ETFs Hold Wash-Sale Rule Advantage

With only 34 days left in 2005 -- and just 24 of those being trading days -- time is running out for investors determined to manage their portfolios in the most tax-savvy way. Exchange-traded funds may be one way to avoid being washed away by the "wash-sale" rule.

Unlike actively managed mutual funds, which report their holdings on a quarterly or twice-annual basis, exchange-traded funds update their portfolio components and weightings on a daily basis on most ETF Web sites. This transparency gives investors the ability to shop around until they find an ETF that will enable them to perform a basic tax-planning strategy called a tax swap, which entails the sale of one security and the simultaneous purchase of a similar, but not identical, one.

For example, say you sell drug stock ABC for a loss, and buy a drug-stock-based ETF called XYZ to replace it. You can use the loss from selling ABC on your tax return to offset gains realized elsewhere in this portfolio. This could help reduce taxes due for the current year, while allowing you to maintain your exposure to the drug sector even after selling ABC. ...