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Checking your investments more often can be a great way to end up out of pocket.
This wisdom, derived from behavioral finance experiments that show that information overload leads to “thinking losses,” can lead investors to believe that they should “set and forget.” However, experts insist that you should be aware of what you’re dealing with, and even if you want to have the same exposure, you should make sure there’s a way to make it cheaper now.
This is often the case in the fast-growing investment fund industry. First, exchange-traded funds usually offer much lower fees than their mutual fund counterparts, and this partly explains why they continue to command market share. But even in the ETF market, price competition has been fierce, so it’s worth making sure you own the lowest-fee version of the ETF you own.
Then, once you look at fees, the decisions become increasingly complex, experts warn, and take extra into account if you’re an overseas investor in US equity funds.
First, you should consider the cost of switching to another fund with similar exposure.
There will be transaction fees to consider. If your original investment has greatly appreciated in value, there may be significant capital gains tax to pay.
Investors should also think carefully and seek advice in selecting the funds they need.
“Investors have to think about many factors when considering funds after determining their desired exposure, including currency, fees, transaction spreads and tax considerations,” said Brett Pybus, head of investment and product strategy at iShares Emea.
Balancing all these costs can be a complex task and suggests that there is no one-size-fits-all advice to give an investor because it depends on the individual situation.
However, Pibus says that tax is something that investors often overlook.
“The behavior we’ve seen in the past is that people tend to look for the biggest and most liquid yield and tend to ignore tax issues, but the clients we’re talking to today understand why we’ve created different ETFs with similar exposures,” Pibus said.
For investors seeking exposure to US stocks, an important factor to consider is the withholding tax on dividends.
When a U.S. company pays dividends to a non-U.S. citizen, a 30 percent tax rate applies, although many overseas jurisdictions have treaties that cut this in half to 15 percent, said Roger Weiss, a tax partner at law firm Wilkie Farr & Gallagher. He explained. The tax applies to distributions in US ETFs and mutual funds.
The capital gains tax burden helps explain why Irish-domiciled USITS ETFs have more benefits than Ireland-domiciled USITS ETFs, which have to pay the full amount.
“A US ETF or mutual fund is not tax efficient for a non-US investor,” Wise said.
Nevertheless, investors who take the right set-it-and-forget-it advice can still own US-domiciled versions of US equity ETFs that predate their foreign counterparts. This ownership is another thing to consider carefully. For example, you may be able to save by moving to an Irish-residential UCITS ETF, but you will still face capital gains tax when you sell your main holding.
Also, while an investor may end up tax-wise better off investing in a non-US-domiciled fund, they may lose out on liquidity and fees.
Funds with higher liquidity can have narrower spreads, which lowers trading costs, Wise pointed out. But it depends on how much you intend to trade – for most self-directed retail investors who trade relatively small volumes, liquidity can be a relatively minor factor.
When weighing tax issues, there are additional complexities associated with your broker, such as if you have U.S. equity exposure through a pension scheme or insurer.
Pension plans and other institutions such as sovereign wealth funds depend on their own tax status and may avoid paying US withholding tax, but not all institutions have this status.
“Not all institutions and countries are tax free. Not all pension funds may have covenants and many private banks, for example, are responsible for minimizing tax, said Keshava Shastri, head of capital markets at DWS.
For investors in the US and Europe, there are well-established domestically listed ETFs that allow investors to invest globally. For investors in certain markets in Asia and Latin America, holding Ucits ETFs can be tax-efficient for certain exposures away from their home markets, such as US equities.
“We always say investors need to know what they’re holding. And for ETF investors, that means looking at the ETF housing they’re holding,” Pybus said.
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