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taxation on index fund holdings


racemize

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Hi All, I'm working on an essay that relates to how much better active investors have to do to beat index funds over various holding periods, and given different turn-over rates.  In order to make this comparison, I need to figure out how index fund holdings are taxed.  After some research, here's what I think I know:

 

Capital gains distributions appear to not really ever happen (I would have expected some amount due to changes in companies in the index).  From my reading, I've gotten the impression that it has to do with the fact that more and more money flows into the index funds, but I never got a clear understanding of it.  Is this a phenomenon that can continue?

 

Dividend taxes on the dividends received.  Currently that amounts to taxation of only ~2% of funds per year (given a 2% yield).

 

Otherwise, cap gains taxes just hit at the end.

 

 

Please correct any of the above if I am not stating it correctly.  I've never owned an index, so I had to ask a EMT friend of mine to look up his index taxes for the last few years to confirm that the above at least appears to be mostly correct.

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At least from what I'm seeing on the S&P 500 index products, there are very, very little capital gains paid out. None within the past 5 or 6 years.

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My understanding is that their turnover is very low (as one would expect with a cap weighting) but not zero.  I show about a ~3% turnover ratio for the spy.

 

yes, but somehow they manage to not have cap gains distributions, which I haven't been able to fully figure out. I think it is even true for funds and not just etfs.  I was hoping someone who understood this well could explain it, but I'll keep digging online.

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