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Want to know how an ETN differs from an ETF? Read this to find out.
Difference Between ETN and ETF
So, what is the difference between ETN and ETF? For most folks, the exchange traded note (ETN) is a new thing. Some even think that an ETN is the same animal as an exchange traded fund. That is not true. In this post, I’ll discuss the differences of the two and a bit of strategy.
Both the ETN and ETF attempt to match a market barometer like a stock or bond index. They are tax efficient, have low fees, and lower investment minimums. A solid alternative to mutual funds that can save you money. Plus, you can trade them all day long if you’d like. They trade like stocks.
However, ETFs and ETNs are two differently traded products. An exchange traded fund mirrors an index by holding a collection of diversified securities. As an ETF investor, you know that if underlying assets fail to perform your investment loses value.
Difference Between ETN and ETF
Exchange traded notes don’t own anything! An ETN is unsecured debt typically issued by a bank. When you buy an ETN you are simply getting a promise from the debt issuer to pay you back the index return minus any fees.
Get it? You take on risk that the index won’t perform PLUS you take a chance that the issuer could default on the note. Credit risk, anyone? Really? Uh, no…make a heavy bet on the wrong ETN and you’ll pay the price!
Wait…even though there is all this extra risk ETNs have an advantage (whether it outweighs the risks is up to you):
Tax Benefit. ETFs distribute interest and dividends to shareholders annually from the fund’s underlying securities. ETF investors in taxable accounts must pay taxes on their distributions. This is sometimes as high as 35%!
An ETN takes the dividends and interest and adjusts its net asset value. So, ETN investors pay taxes when they sell the ETN. If the investor holds the ETN for longer than a year they pay 15% long-term capital-gains.
Difference Between ETN and ETF
You may be wondering about commodity ETNs? Like for oil or gold? They are quite popular and have a tax edge too. Investors that own a commodity ETN pay taxes when they sell. If they hold longer than a year it costs 15%.
Most of the commodities ETFs invest in futures contracts set up in master limited partnerships (MLP). So, most of these investors have to deal with Schedule K1 forms. Yuck! Plus, they pay taxes on capital-gains realized by the ETF during the year even if they didn’t sell. Double Yuck! Ready for the TRIPLE Yuck? If an investor’s ETF contains precious metals the tax is 28%! The Internal Revenue Service considers precious metals (like gold) a collectible and taxes accordingly. Forget about 15%.
So, the difference between ETN and ETF is substantial. This was an overview. Make sure to check out all the nuances of any exchange traded notes or funds before investing.
Source Material:
Carrel, Lawrence. “When Exchange-Trade Notes Trump ETFs” Kiplinger’s. Aug. 2011: pg. 33. Print.
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