I’ve been wanting to write an article on ETF investing for quite a while. That’s because multiple friends have been asking me for investment advice. This, by itself, is highly questionable of course, because these friends were under the assumption that I was supposedly a smart, structured person and therefore that my personal investment decisions would be equally smart and structured.
I’m not really sure whether any of those assumptions are correct, but nonetheless I still had a few interesting thoughts and experiences with ETF investing I’d like to share with you here.
However, I’ll skip all the ETF basics here – I tried writing those up multiple times and the result was brutally boring every time. The Internet ™ has already done a decent job of providing “ETF investing for beginners” content. If you’re a newbie starting out, check out the ancient book by Benjamin Graham (which, ironically, is not “The Internet”), the Bogleheads community and wiki, and if you prefer something written in German by a serious-looking person managing more money than he has hair, check out the books by Gerd Kommer, they’re supposedly pretty solid (haven’t read them).
Anyway, on wards – this is not about ETF basics – instead, I’d like to focus on aspects which I wished someone had told me when I got into (and sometimes out of) ETF investing.
Let’s get started.
You Save Taxes With Accumulating ETFs
This is somewhat counterintuitive (well, all of these points are) and only applies to countries in which 1) there is a capital gains tax and 2) you can purchase so-called accumulating ETFs (like in the EU and not in the US).
Here’s the idea. Let’s assume you compare two ETF investments. One pays out its dividends every time, and the other one reinvests them (= the accumulating one):
- Every time the “dividend ETF” pays out dividends, those are taxed at your country’s capital gains tax rate, e.g. 26% in Germany. Afterwards, you get to reinvest the remaining 74% of the dividend. Cool.
- On the other hand, every time the accumulating ETF would pay out dividends, it reinvests 100% of them instead (not 74%!). You don’t pay capital gains tax on these “virtual” dividends which were reinvested. So you reinvest much more money. In the long run, this leaves you with much more money, because that additional reinvested money goes on to further increase in value, etc., etc.
Now, this is slightly simplified because, in Germany, you do pay capital gains tax on reinvested dividends, and it’s called “Vorabpauschale”. However, the big takeaway here is that this generally is lower than what you would have paid with the dividend ETF paying out the dividend to you, i.e. the 26%. Here’s a calculator for the Vorabpauschale. Yes, it’s usually less than the 26% on paid-out dividends.
Therefore, it’s beneficial to choose accumulating ETFs. Which brings me to..
The #1 Feature of ETFs Is Peace of Mind, Not Performance
In the whole investment discussion, people like shouting at each other (online) about highly specific stuff like “how many bonds should my portfolio have” or “is the ACWI better than the MSCI World”.
All of this matters.. to a degree.
But let me tell you something way bigger from my experience: The #1 feature of ETFs is peace of mind. What do I mean by that?
Picking specific stocks to buy is called “stock pocking”, and it’s frowned upon in the ETF investment community because a typical human, when picking stocks, underperforms an index ETF.
I used to do stock picking.
Somewhat surprisingly, I did reasonably well – for example I was lucky to pick AMD just before they started shipping their insanely good CPUs. This was back in the stone age, 2017 or so.
But, regardless of performance, stock picking has one gigantic drawback hardly anyone talks about: You’re constantly checking on your portfolio.
Let’s say AMD releases a new CPU. You read it in the news. Damn – should you buy more AMD stock now? Or sell your existing stock because it went up? Or buy Intel because they’re undervalued now?
Think about all those minutes, hours, days you spend ruminating about your portfolio. Sometimes, those thoughts lead to trades. Sometimes those trades are good. Sometimes not. But all of that is besides the point: You could have spent all that time working productively in whichever field you’re good at. Maybe as a software developer, as a designer, or as a company founder. Likely not as a trader.
And the “return in time investment” would have been much better! Say, you’re a software developer making 100€ / hour. Instead of checking on your portfolio, you work more on put that money in an index ETF. I’ll bet you outperform whatever stock picking you would have done with that time, simply because you spent your time productively earning money.
And this doesn’t even take into account that the vast majority of people doing stock picking underperform index ETFs! Sure, there are people like this friendly hobbit who regularly outperform the market, but those people spend their entire work life analyzing stocks.
Don’t do that. Do something productive instead.
Invest in ETFs with peace of mind, gain more time. Spend that time on working more productively. Invest even more into ETFs. Outperform stock pickers. Easy.
And then there’s even more to that: Because you’re hardly checking on your portfolio, you also become much more capable of holding onto your investments when the market crashes. And that’s huge! Because the one big mistake you can make is panic-selling your investment when the market goes down. ETF investing makes that much less likely. Talking about crashes..
ETFs Crash Less
There’s surely some smart technical term for describing this, but I’ll just keep it simple and subjective: When the market goes crashing, ETFs crash less. This is easily forgotten!
When markets are going up, every stock picker points at their portfolio and says things like “look at my Nvidia shares, they’re going up! I’m good at this!”.
There was this quote somewhere that “in a bull market, everyone looks like a genius”, and it’s true.
But here’s the thing: What if the market comes crashing?
Then, things get ugly.
Tesla is currently down ~40% from it’s all-time high while I’m writing this. Imagine you were one of the stock pickers and invested large chunk of your savings in Tesla. Crazy. 40% gone. Meanwhile, ETFs like the MSCI World or ACWI are moving sideways. Or maybe they’re down 2% or so. This is huge. Compare temporarily losing 2% of your money vs. losing 40% of it.
Sometimes, it’s easy to forget the true magic of index ETF investing: You just purchase an ETF and it starts rebalancing itself behind the scenes, without you noticing anything. Tesla is going up? No worries, you’re invested via your index ETF. In fact, your index ETF is buying more of Tesla because its market cap just went up.
Tesla is going down? No worries, your index ETF is already selling Tesla shares and buying other company’s shares instead.
It’s magical.
If ETFs were able to demonstrate their magic in a more obvious way, say, by showing a livestream video on YouTube where 1,000 traders are sitting in a room and live-rebalancing the ETF by buying and sharing shares based on their changing market cap, then, well ETFs might be way more popular. Because they look super fancy and technical, and people love super fancy and technical things!
But, alas, index ETFs just mostly boil down to computer programs running on some boring servers in some boring data center, so it’s up to us humans to grasp the true magic of them. And not all of us are able to do so.
ETFs + Capital Gains Tax = Locked In. Rebalance With New Money
People like to talk a lot about rebalancing and how often to do it. Let me tell you this instead: In countries with capital gains tax (the US people call this a “taxable account”), there is no such thing as rebalancing. That’s because of capital gains taxes.
A quick example. You want to allocate 90% of your portfolio to the MSCI World, and 10% to the MSCI Emerging Markets. Here’s your portfolio, with its gains so far:
- MSCI World: 90k€, 45k€ of which are gains (+100%)
- MSCI EM: 10k€, 5k€ of which are gains (+100%)
In this hugely simplified example, you purchased each ETF at 45k€ (MSCI World) and 5k€ (MSCI EM), respectively. Each of them performed well and stands at +100% now. Cool.
Now you choose to rebalance to some other percentage, say 80/20. You’d have to sell a chunk of the MSCI World, and purchase more of the MSCI EM.
But here’s the thing: This would be tremendously stupid from a tax perspective. Because on your significant gains in the MSCI World, you’d be paying 26% capital gains tax (at least in Germany) on those gains, leaving you with way less money than before. So some of your gains, which you actually wanted to take and rebalance into the MSCI EM, simply disappear as taxes. Ugh.
If, instead, you just leave the money in the ETF, accepting some “portfolio imbalance”, your total return is likely going to be higher, as that money continues to earn returns.
So just leave it as-is.
If you really do want to rebalance, do so when you’ve made more money and about to invest that. Then, with that new money, you’d go ahead and purchase more of what is currently “under-represented”, in this case the MSCI EM (yes, it’s a good idea to create a spreadsheet to calculate these things).
Got Huge Unrealized Capital Gains? You Could Just Leave The Country
This is somewhat a controversial point, but I thought I’d still write it down for you as it took me a while to understand this and it cost me real money to confirm this with tax advisors. Two disclaimers: It won’t work for US people (you’re taxed by citizenship, good luck with that) and it will really depend on your situation (tlak to a professional).
Anyway, here’s the idea. Let’s say you have pretty huge unrealized capital gains – let’s take the example from earlier and simplify it, here’s our portfolio:
- MSCI World: 100k€, 50k€ of which are gains (+100%)
Okay, so now you’re looking at that and going like “damn, if I sell all of those 100k€, I’d be taxed 26% on my gains of 50k€, so I’d be paying 13k€ taxes” (side note: simplification as the exact percentage is lower for stock ETFs in Germany). So in this example. you’d end up with 87k€ on your bank account after selling your position of 100k€.
Now here’s the huge hack: Depending on your current country, you could simply temporarily move your tax residency to another country which doesn’t have capital gains taxes, sell your 100k€ position there, get the full 100k€, in cash, come back to your “old” country later and re-invest those 100k€.
Technically, this would work. It of course depends on 1) your current country and its exit taxes, 2) your planned “other” country and 3) all sorts of other implications which (usually) only a very-expensive international tax advisor can resolve.
Looking at the situation in Germany, it’s currently possible because the German exit tax (which I wrote about here) only affects your ETF holdings where the purchase value was 500k€ or more (per ETF). If it’s below that, you could simply leave Germany as a tax resident, move your ETF holdings somewhere else, too, realize your capital gains and not pay any taxes on those. So, in the above example of the 100k€ MSCI World position, it would work.
You could even come back to Germany with the cash and re-create your portfolio again, this time with less accumulated gains, thereby paying less future capital gains taxes.
On a slightly funny note, this would actually solve the “you can’t rebalance your portfolio due to capital gains taxes” problem above: Any time you want to rebalance your portfolio, simply move to a country which doesn’t have capital gains taxes. Easy, right? Well, some people might say it sounds rather cumbersome to be moving countries every few years, chuckle.. but yeah, it’s possible.
Of course there all sorts of ethical and moral questions here, just like with any gray area “tax optimization” scheme. The decision is up to you. Still, I thought this was certainly interesting enough to share.
Lesser-Known ETFs and Funds
Before concluding this article, I’d like to share a few ETFs and funds with you which I only learned about a few years into investing. If you haven’t heard of them yet, they might come in quite handy!
- Xtrackers EUR Overnight Rate Swap (DBX0AN):
This essentially resembles the central bank interest rate. Pretty cool if you want to temporarily invest some money for a short period of time and your bank doesn’t offer you a good interest rate in your savings account.
Technically, it’s less “safe” than cash in your bank account (which is protected up to 100k€ in Germany per bank account), then again, the underlying securities are government bonds, so it’s reasonably safe.
This would be a cool ETF to buy if you e.g. have a lot of spare money in your account which you’ll be spending in a few weeks or months, like when purchasing a house, paying off a large sum of taxes, etc. Just put it in this money market ETF and earn a few percentage points in the meantime. - Euwax Gold II (EWG2LD):
When investing in gold in Germany or the EU, people like to mention Xetra-Gold because it’s the most well-known, um, “entity” through which you purchase gold for your portfolio (apparently they also offer physical delivery of the gold – I’d be really intrigued to try this out). But the fee structure of Xetra-Gold is rather annoying, as your broker will deduct monthly fees from your account in relation to your gold holdings.
Euwax Gold is better in this regard as you only pay fees when you purchase and sell. It’s issued by the stock exchange in Stuttgart, so purchase there in order to get the best rates.
My Portfolio
Ah, right! I actually forgot the best part. Here’s my portfolio in case you were interested:
- 90% MSCI ACWI
- 10% Global aggregate bonds (Euro hedged).
Besides that, I try to keep one year’s worth of expenses in cash in a savings account with some interest. If you’re not self-employed like I am, you could likely keep less.
Anyway, hope these lesser-known “magic benefits” of ETFs were useful for you.
Write a comment below what you think!
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