Exchange-traded notes

With exchange-traded funds (ETFs), issuing banks holds a basket of underlying assets that trade at close to net asset value. Especially for passive investors, it's easier to buy a single ETF than to buy the basket of assets individually while maintaining the portfolio's proportions. It's also tax efficient because there are fewer transaction costs.

Exchange-traded notes (ETNs) take a different approach. They're unsecured debt securities whose payout tracks a basket of assets. In effect, a bank asks for money in exchange for a promised return at predetermined multiple of an underlying benchmark at a later date. This structure means your entire return is taxed as long-term capital gains (15%), avoiding the ordinary income tax (35%) on interest and dividend income.

The main downsides are that you bear credit risk of the bank issuing the security and you have less liquidity.

Note: The future of the tax treatment of ETNs is uncertain.