No. of Recommendations: 3

You wrote, We have learned by experience that ETFs are better in taxable accounts. Too many times we have been hit with huge capital gains distributions from our mutual funds, which we keep since selling them would trigger even bigger ones. FWIW these are managed funds. I tend to avoid index funds.

Most mutual funds have to periodically pass on capital gains from any daily net redemptions. If fund redemptions exceed fund sales in any given day, the fund is forced to sell assets to raise cash. This is daily net redemptions. For index funds, capital gains come from the sum of these redemptions plus any changes in the underlying index.

Vanguard avoids the daily net redemption problem by making their ETF shares a class of their regular mutual fund shares and using those shares to do arbitrage. Vanguard has a patent on this technique, so for now other mutual fund companies can't use it without paying a licensing fee to Vanguard.

- Joel
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