A couple of weeks ago, I was faced with what appeared to be a serious problem: my laptop wouldn’t run.

In a rush to prepare for a media event, I frantically called my self-proclaimed king computer geek who late on that ill-fated Sunday night, proceeded to race me through a complex list of possible causes. Just when it appeared my trusty Mac was headed for computer heaven, on a last ditch effort he somewhat reluctantly asked if the thing was plugged in.

Glancing at the power source, my face must have turned bright red; indeed, the cause of the problem was that one very obvious thing, leading me to once again realize that sometimes we’re in such a hurry that we can occasionally overlook a few simple things.

When it comes to investments and saving taxes, the “one obvious thing” I occasionally forget to check appears on page one of the 1040, lines 8a and 9a, otherwise known as taxable dividends and interest.

Turning to Schedule B, the culprit causing these taxable dividends and interest is often the result of investing in managed mutual funds. Often, but certainly not always, working people are not using these dividends and interest for income. On the contrary, the person is often investing these monies outside a tax deferred qualified plan (such as an IRA or 401k) and planning to let it sit there and (hopefully) grow for future use.

Although I’m a big fan of some managed mutual funds, when it comes to saving taxes, reducing fees and potentially increasing rates of return, this is the one area I usually first turn to the most.

Often, right there on Schedule B I’ll see a brokerage account and/or some mutual fund company(s) listed that are throwing these taxable dividends, capital gains and interest over to page one of the return.  It’s at this point I will often give some information on what I call one of Wall Street’s greatest inventions, the illustrious “Exchange Traded Fund,” otherwise known as an ETF.

If you haven’t heard of an ETF, I would highly recommend learning a few things about them. Although it’s rare when I get excited about any investment product, when it comes to ETFs, I’m usually reaching for my seven year old’s pom-poms to help sing praise to them.

Please understand, an entire book can be written about ETFs but in the interest of this brief column, I’ll try to keep this real short and hopefully simple.

An ETF is a somewhat related cousin to that of a mutual fund, but there are a few big differences, perhaps best summarized by the simple chart below. Please keep in mind, these are general points and not necessarily true of every ETF. So, as with any investment, please don’t take these as exact; the points expressed should only be construed as examples. As with any investment, be sure to first understand the exact product before investing in any of them.

With that in mind, here goes:

TAXES

When it comes to taxes, ETFs can be quite tax efficient. Given most ETFs are passively managed (the internal stocks within the position rarely get traded), ETFs typically distribute very little capital gains during the year.

In many cases, when I hear an investor complain about the amount of tax they are paying, my first question is “are you investing in managed mutual funds outside your retirement accounts,” and the answer is very often, “yes.” By looking at a tax return and carefully researching the positions within the person’s brokerage accounts, I can quickly provide a general assessment as to the tax ramifications the funds are causing.

If you aren’t familiar with ETFs, I would suggest checking out Yahoo Finance and/or ETFConnect.com. As to how you can research a mutual fund’s tax ramifications, above and beyond looking at a tax return, you may want to check out www.morningstar.com and a lesser known website that is one of my favorites, PersonalFund.com. Both of these offer various insights into a particular fund. When assessing tax ramifications, be sure to pay close attention to something called “Turnover.”

Turnover refers to the amount of times a fund manager sells holdings within the fund. Often, you’ll come across something called Turnover Ratio which is expressed as a percentage. A Turnover Ratio of 100% would mean the fund manager sells all holdings of the portfolio during the year and replaces them with something else. A Turnover Ratio of 50% would obviously mean half of the portfolio is replaced during the year, etc.. Needless to say, the higher the turnover ratio, the more likely it is that  capital gain taxes are being passed off to you.

Of course, this isn’t to say a portfolio of managed mutual funds should be quickly replaced with ETFs. There are obviously a lot of considerations that need to be taken into account before anything is ever replaced, especially when tax considerations are involved.

But when it comes to trying to save a few dollars in taxes, likely pay less fees and increase performance,  this is one way to potentially save a handful of taxes I personally wouldn’t want to miss.

Do you have any other “obvious” tax savings ideas? If you do, please, drop me a comment or email. I’d love to hear all about them.

Have you ever heard of an “Exchange Traded Fund,” otherwise known as an “ETF?” If you’ve  ever invested in mutual funds but never heard of an ETF, you owe it to yourself to learn a little about what I often call one of Wall Street’s greatest inventions ever.

Like a mutual fund, an exchange- traded fund (ETF) pools money from investors to buy a group of securities. Though diversification alone can’t guarantee a profit or protect against potential loss, such an investment helps you spread your risk over many individual securities.

Most ETFs are passively managed. Instead of having a portfolio manager who uses his or her judgment to select specific stocks, bonds, or other securities to buy and sell, ETFs try to approximate the performance of a specific index, which can be either broad-based or narrowly focused. In this, they are somewhat similar to an index mutual fund.

However, there are some substantial differences between mutual funds and ETFs. Perhaps the biggest is the ability to trade ETFs throughout the day. Mutual funds are priced once a day after the market closes. If you buy or sell after that, you’ll receive the next day’s closing price. By contrast, ETFs are priced throughout the day. Also, they can be bought on margin or sold short; in other words, they can be traded just like stocks. As a result, investors may use ETFs to actively trade a particular sector or industry.

ETFs typically have no minimum investment requirements or redemption fees for brief holding periods. And because most ETFs are based on an index, the administrative costs can be relatively low. However, ETFs must be purchased through a broker. Since you’ll pay a brokerage commission with every transaction, ETFs may not be well-suited to a systematic investing program such as dollar cost averaging–transaction costs could quickly eat up any cost efficiencies.

Because the differences between one ETF and another can be dramatic, you should carefully consider a fund’s investment objectives, risks, charges, and expenses, which are included in the prospectus available from the fund. Read it carefully before investing.

There are many ways an exchange-traded fund (ETF) can be used to help round out or supplement an existing investment portfolio.

Investing in a sector rather than an individual stock. An ETF allows you to invest in an industry or sector without relying on the fate of an individual company. If you have broadbased stock funds, you can give more weight to a particular sector by also investing in an ETF that focuses on a relevant index.

Minimizing taxes. ETFs can be relatively taxefficient. Because a passively managed ETF trades relatively infrequently, it typically distributes few capital gains during the year. That means you won’t incur the same tax liability as if you received significant capital gains. However, make sure you consider just how an ETF’s returns will be taxed. Depending on how the fund is organized and what it invests in, returns could be taxed as short-term capital gains, ordinary income, or even as collectibles, all of which are generally taxed at higher rates than long-term capital gains.

Staying invested after selling stock for a tax loss. If you have sold a large stock position to realize a capital loss for tax purposes, but still believe that industry as a whole will soon experience a big short-term move, you can use an ETF to try to take advantage of that volatility. If you buy the same stock within 30 days, the tax-loss deduction will be disallowed. However, buying an ETF based on a relevant index as a proxy for that investment until you are able to buy the stock again allows you to preserve the tax deduction on the stock loss while staying invested in that industry.

Limiting losses. With an ETF, you can set a stop-loss limit on your shares. A stop-loss order instructs your broker to sell your position if the shares fall to a certain price. If the ETF’s price falls, you’ve minimized your losses. If its price rises over time, you can increase the stop-loss figure accordingly. This strategy lets you pursue potential gains while setting a limit on the amount you can lose.

Be sure to carefully consider a fund’s investment objectives, risks, charges, and expenses, which are included in the prospectus available from the fund. Read it carefully before investing.