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Exchange Fund Basics
What are exchange funds, and what are the benefits of participation?
What are exchange funds, and what are the benefits of participation?
Updated over a week ago

Exchange funds, also known as swap funds, are private investment funds that allow investors to diversify their stock positions tax efficiently by exchanging stocks for shares in a broader portfolio. These funds accept stocks from a variety of companies, and each investor receives a share of the pooled fund that is equal to the value of the stock they contributed.

There are two primary benefits:

1. To help investors meet their diversification objectives, each fund is built around a benchmark index, such as the Nasdaq-100 or Russell 3000. By doing so, they reduce volatility and investment risk in concentrated portfolios. Keep in mind that these funds are designed to diversify – not to outperform the contributed stock positions. And all exchange funds carry some risk, including the risk of losing principal in the fund.

2. As a tool for long-term financial planning, exchange funds also allow participants to defer capital gains taxes when they diversify. By doing so, investors can diversify without experiencing tax drag, and they are left with more principal to compound over time. To better understand the potential tax benefits, see our exchange fund simulator.

Though investors are diversified upon contribution, they must remain in the fund for seven years before they can withdraw a tax-deferred basket of stocks. Exchange funds are structured as limited partnerships, and the fund is also required by tax rules to hold 20% of its assets in qualifying illiquid assets, such as real estate or commodities.

Here are more detailed resources we've written to help you understand how exchange funds work:

As you consider your long-term financial plan, here are some data points to keep in mind about concentrated stock portfolios:

  • The probability of any stock outperforming the market is low. For example, between 2001 and 2023, 73% of the stocks in the Nasdaq-100 index underperformed the index -- and 44% of those stocks actually lost money. (Source: Internal research, based on Bloomberg data.)

  • Over a longer timespan, index funds have produced higher risk-adjusted returns than all but a handful of stocks. The average equity investor underperformed the S&P 500 by 4.32% over the 20-year period from 1992–2011. (Source: 2016 Dalbar QAIB Report)

  • A 2022 study of almost 100 years of US stock market data found that stocks that were among the top 20% of performers for any five-year period went on to lag the market 86% of the time over the next ten years. (Source: Brooklyn Investment Group)

With Cache as your exchange fund provider, you’ll exchange your stocks for a diversified fund without triggering taxes. This tax deferral ensures that 100% of your pre-tax dollars stays invested in the market, compounding over time. Assuming historical stock returns, this could add to a sizable advantage over time.

Like any investment, participation in exchange funds can also carry risk, including the loss of principal and limited liquidity during the fund's life.

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