Over the last few years, a new breed of mutual fund has become available to investors seeking liquidity and lower costs. These funds, called exchange-traded funds (ETFs), trade on the major exchanges and behave just like stocks, except that they offer the same type of diversification and professional management available in traditional funds. Over 350 different exchange-traded funds are now available, and the number is continuing to grow.

These funds can be useful for investors seeking to reap capital losses at year-end. For example, assume that you have stock in a certain technology company. The stock price has dropped precipitously since you got in, but you feel that this is only temporary. However, you would like to realize a capital loss on the stock while it is trading in its current range. But you must watch out for the “wash sale” rule as dictated by the IRS prohibits the repurchase of any stock sold for a loss for at least 31 days following the sale. Therefore, an ideal solution could be to sell the stock and buy shares of the appropriate corresponding exchange-traded technology fund. Even if this fund actually has your former stock as one of its core holdings, it is still considered a separate security by the IRS and the SEC. Therefore the wash sale rules will not apply.

Furthermore, you now have diversification within the technology sector, while retaining the same liquidity as before. Since numerous studies have shown that the majority of return on equity is due to asset class as opposed to individual stock selection, it is possible that you will realize a similar rate of growth from your new fund holding while reducing your overall risk. The proliferation of exchange-traded funds now allows you to realize a loss with one fund and then jump into another if you desire.

And when should you swap? The obvious answer is when you have capital gains or other income that you would like to declare a loss against. A loss can be declared against the amount of any gain received, plus $3,000 of ordinary income per year.