Which Kind of ETF Is Right for You?

In the last few years, exchange-traded funds (ETFs) have expanded dramatically. From focusing on sectors to targeting regions, each type of ETF now can strategically solve problems for investors and money managers. These days there are commodity ETFs, leveraged ETFs, and even ETFs that act like hedge funds. While active management is important in times such as these to navigate the sensitive waters of macroeconomic change, ETFs are a major advancement in having investment funds with low fees that can manage holdings that investors seek.

Many times an ETF can simplify life as they are able to invest in assets and securities on stock markets around the world, which also saves time for investors and managers. Simply put, a money manager may charge an investor 1% or more to manage investments for the customer. However, many public investors may now open an account with a major brokerage firm and simply invest in ETFs with lower expense ratios and fees. Thus, The ETF may act like a money manager. Whether you need income, growth, or international exposure to markets, ETFs continue to expand with efficiency and versatility. With the evolution of ETFs, there continues to be opportunities for continued expansion toward strategic ETF creation.

High-Income ETFs for Income or as an Inflation Hedge.

All of these types of ETFs are fairly new and innovative. Some have high yield and high expense rations; thus, research and screening is important to meeting your suitability and needs.

  1. Some ETFs manage MLP Master Limited Partnership assets which have some tax advantages. An MLP is a master limited partnership which is a business venture that exists in the form of a publicly traded limited partnership. They combine the tax benefits of a private partnership—profits are taxed only when investors receive distributions—with the liquidity of a publicly traded company.
  2. Other ETFs own or reflect BDC companies with high dividend yields. A business development company (BDC) is an entity that invests in small to medium-sized companies along with possibly investing in distressed companies. A BDC helps the firms grow in the initial stages of their development or helps challenged businesses regain sound financial footing. Thus, a BDC ETF would be a diversified BDC holding with high income.
  3. Some new ETFs represent a CEF Closed end Fund. A closed-end fund is not a traditional mutual fund that is closed to new investors. A CEF is an investment structure and entity, organized under the regulations of the Investment Company Act of 1940. A CEF is a type of investment company whose shares are traded on the open market, like a stock or an ETF. A CEF invests in a portfolio of securities and is managed, typically, by an investment management firm.
  4. The last type of high-yield ETF innovation to include here are “REIT ETFs”. A real estate investment trust (REIT) is a type of company that owns, operates, and/or finances “income-generating real estate”. Thus, a REIT ETF can own various REIT investments which may be somewhat diversified. These types of investments may also have upside as the value of certain properties may increase along with the increases in revenue from the real estate.

As a note to retirement accounts, many of these higher-yield ETFs that are used within a 401(k), IRA, or tax-deferred account are generally immune from annual reporting and annual tax filing and thus you receive high income in your retirement account that is untaxed until you take it out. If you own these ETFs in a taxable account, you would generally be required to report any income on your 1099s of interest, dividends, or gains. * Special note. It is said not use MLPs within any retirement account as there may be tax due or reporting requirements, but inclusion of CEFs, REITS, and BDCs may be a secret to growing a retirement account during an underperforming market or inflationary period.

As a note, MLPs are corporate tax pass-through entities. Further, many of their distributions “tax free” and are simply a reduction in the investor’s tax basis and therefore taxed when the investor sells their position. MLPs generally issue K-1 partnership tax forms for reporting, and these can look complex, but each tax preparer needs the K-1 to input all of the annual changes. As a note, the real beauty of an MLP is that the tax basis is stepped up upon the death of the owner which means that the owner received higher yield and “low taxed income’, while the surviving spouse or heirs get a new tax basis and can sell the asset without capital gains.

To be sure, it is always good to look at several things in an ETF. Look at the track record and performance, the management, the dividend yield, and look at the exposure. Some ETFs have vast exposure to offshore banks, real estate in regions that are less favorable, risky lending, and more. Therefore, many of the ETFs with a focus on income such as: REITS, MLPs, BDCs, or CEFs are looking for yield that comes with risk. Thus, if you are approaching or within retirement age, please consult with a qualified and licensed advisor before making any important investment or tax related decision.

Overall, if you are looking for low expenses and high income, there are a wide array of ETFs out there with very specific strategies and some ETFs even offer tax strategies also.

George Mentz JD MBA CWM Chartered Wealth Manager ® is a licensed attorney and CEO of GAFM ® global education, which is an ISO 29990 Certified professional development company operating in over 50 nations. Mentz is an award-winning author and advisory board member to several companies around the world in education, charities, and FinTech Companies.

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