ETFs vs. ETNs

Which Investment Is Best for You?

ETFs vs. ETNs
October 19, 2015

You have probably heard of exchange traded funds (ETFs), but you may be unfamiliar with exchange traded notes (ETNs). They are similar in that both track some form of asset, trade on the major stock exchanges and have relatively low expense ratios compared to an actively managed fund. The main difference, and most of the differences that follow, relate to the underlying assets.

ETFs actually hold the assets that they attempts to track, whether the assets are stocks, bonds, commodities, precious metals, or other financial entities. Returns are based on the assets that are held by the fund. Assets are managed to stay on track with the index.

In contrast, ETNs are debt notes — unsecured debt issued by a financial institution (typically a bank). Their returns are based on a market index, but there are no holdings in the indexed assets. ETNs act like bonds in several ways. They can be held to maturity and redeemed for the cash amount based on the index on that day, and may be bought and sold at any point in the life of the note.

Whether an ETF or an ETN is right for you primarily depends on their differences in three important aspects.

  • Risk Risk for an ETF is based on the assets that are held and the ability of the fund to properly track that asset. An ETN has a second layer of risk since the underlying debt is unsecured. Should the credit rating of the debt issuer drop, the ETN value will drop independently of the index, and in case of bankruptcy, the investor could face a default situation. In essence, ETNs have two potential mechanisms for a decrease in value.

Even so, there may be tracking error involved in an ETF, since the ability to track the index properly is dependent upon the fund’s management. Thus, one could argue there are also two levels of error with an ETF: the value of the underlying stocks and the failure to track the index properly.

  • Taxes Tax treatments of ETFs are complicated, and taxation rules of ETNs are still relatively murky, so verify the latest tax status with the IRS or a trained tax professional before investing. However, we can make a few important generalizations.

Currently, ETNs are taxed when the ETNs are sold or redeemed for profit and are subject to capital gains taxes. Short-term income from ETNs is taxed at the rate of ordinary income; beyond one year of holding, ETNs are taxed at the lower long-term capital gains rate upon sale.

Taxation of ETFs is not straightforward since their value depends on the underlying assets. As a general rule, ETFs are taxed along with the tax rules of the sector in which the ETF is invested. Your ETF may or may not have the same type of tax advantage as an ETN.

  • Diversification ETFs are diversified because they are invested in multiple assets, which can range across asset classes. ETNs are simply ownership of debt from the issuer and offer no diversification of holdings.

ETFs are simpler for the novice investor to understand, but ETNs can offer advantages if you can handle the risks, and the tax advantages provide an improvement for the same relative amount of return. To determine which type of investment is best for you, select some promising options from a screening list of ETFs and ETNs and check the prospectus to see if the details fit your needs. Do not hesitate to seek the advice of a qualified tax professional if you need help.

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Erin | 10.19.15 @ 14:15
There are so many different types of investments that it gets confusing quickly. Thank you for bringing some clarity to the subject.
Elaine | 10.19.15 @ 14:17
Still not sure about all this investing. Seems confusing.
Daniel | 10.19.15 @ 14:18
I think many people do not realize just how many choices are out there, Having access to great information like this is great as you make you choices.
Steffanie | 10.19.15 @ 14:19
All this information can be so overwhelming. Thank you for clearing some of it up.
Nancy | 10.19.15 @ 14:20
Articles like this while helping clarify things, also make me realize how much I need a professional's guidance.
Angie | 10.19.15 @ 14:20
The ETNs sound quite risky - not sure I'd want to try them...
Carla | 10.19.15 @ 14:21
There is a lot more to investing than I can wrap my head around so thanks for explaining some of the options.
Sarah | 10.19.15 @ 14:21
Because knowing is half the battle.... great info, as always.
Alec | 10.19.15 @ 14:27
I definitely wouldn't want to take the risk with the ETN in case the issuing company goes under. With the way the economy has been and continues to be, it seems more likely. I'd talk to a professional first before investing in the other though.
Zanna | 10.19.15 @ 14:29
I still have a hard time believing these investments are going to pay off, it all seems risky to me. I think I need to learn more about it.
Tina | 10.19.15 @ 14:32
Investing confuses me. These articles are helpful - keep them coming!
Chrisitna | 10.19.15 @ 14:34
Investment language can be so confusing. I appreciate the simplicity in definitions.
Meredith L | 10.19.15 @ 14:37
I had no idea the difference! This is helpful and is important for beginning investors to know the difference before they put their hard-earned money somewhere
Jo Ann | 10.19.15 @ 14:37
Well an investor definitely needs to know this information because of the risk factors. ETNs are definitely more risky since they are not secured.
Rowan | 10.19.15 @ 14:37
Investing has always been something that's confused me, so I stay away from it. Better safe than sorry.
irene | 10.19.15 @ 14:47
I don't invest though we have a relatively safe annuity
Bobbie | 10.19.15 @ 14:53
ETN's sound very risky
Jackie | 10.19.15 @ 14:54
ETNs sound too risky for me. Unsecured debt of any kind doesn't seem like a safe investment.
gracie | 10.19.15 @ 14:55
This was a great breakdown to help make things easier to understand!
Crystal | 10.19.15 @ 14:59
Thanks for breaking these down. I've seen the acronyms but never took the time to investigate. This is helpful info!
Rychana | 10.19.15 @ 14:59
I have never heard of EFT and EFN before this article. I'm still confused about them. Good article. Maybe some illustrations to make it easier to understand.
$commenter.renderDisplayableName() | 11.27.20 @ 05:50