Recently I described “spiders,” traded on the New York Stock Exchange (symbol: SPY). Basically, spiders are synthetic securities that represent your interest in one-tenth of the value of the Standard & Poor’s 500 Index. They’re a way to do just what you would do with an index fund, only a little easier (just call your broker to buy or sell), with a few other minor advantages and disadvantages.
“Spiders look interesting to me as an alternative to Vanguard’s index fund. What’s not clear to me is dividends — do spiders also have dividend income or just capital appreciation?” — Jim Taylor
Yes, Spiders pass through dividends.
“You mention Forbes regarding Spiders. Are those of us who invested in things like the Vanguard version of the S&P 500 in grave danger of being whacked with capital gains taxes if we hold tight and the thundering herd sells?” — AASLCS
Interesting point. Index funds are very “tax efficient” because typically they just buy and hold. If the stocks in the index go up, there’s no tax on the appreciation because they don’t sell. Yes, some shareholders are redeeming shares, but more, typically, are buying new ones, so net-net, Vanguard and the other index funds haven’t had to sell to meet redemptions.
But what if more people redeem their shares than buy new ones, as may have been happening during the recent market downturn? The fund would then have to sell a little stock — or a loot if the redemptions were severe — and thus realize capital gains if, as has been the case recently, the stocks they hold are a lot higher than they were when purchased. Those capital gains then get passed on as a tax liability to the mutual fund shareholders.
It’s important to say that this is not likely to amount to a whole lot of taxes for most people. It’s no reason to bail out of index funds. On the other hand, Spiders would seem to have an advantage in this regard, because someone else’s selling won’t trigger realized capital gains — only your own. You have more control over the tax consequences. So unless I’m missing something here, that’s an advantage of Spiders I hadn’t thought of.