Beginning in Investment - A Better Strategy for the Long-Term

[ClubMan]

I never said I could predict the future.

Sounded that way to me:

We're almost at the height of the bull market now and if we start investing now, we'll ride down, averaging down for lesser value. It's best to wait until the next market cycle to get in (i.e. end of bear market). Remember the Dot Bomb? I know the top 20 weren't as badly affected but still when the whole market is going down, the rest will follow, now matter how strong it is. Have to do more due diligence than buying the top 20.

 

[howdydoo]

Right, I don't know when the next cycle is either but obviously this cycle is well underway. Since we're already so high, the potential for losses are greater. The interest rates are being hiked in UK, EU, and US, so seems the markets may be affected by this.

 

[z108]

Are you for real? How do you know when the next market cycle will begin?

In fairness to howdydoo most people believe markets tend to move in cycles. If he believes also that its overvalued then hes responsible for his investment decisions based on that. Perhaps he could have had a better choice of words and written something like: .... ' I believe We're almost at the height of the bull market now..'...
And any crash will undervalue many stocks when people behave irrationally which is ideally the best time to buy.
If other people believe the oposite I'd like to see the reasons from both sides of the belief spectrum.

 

[fluppet]

Assume dividends are 2.5% per annum, growth is 9% p/a

This seems a little bit high for a long term average.

 

[PMU]

Ronaldo: I think you need to benchmark your portfolio against the Eurostoxx50, i.e. calculate its percentage gain / loss and volatility (i.e. std. deviation).

Before you make any decisions on subsequent stock purchases / disposals, anyone followign this stratedgy would need to see if the portfolio is: (a) giving you a better or worse return to the index; and (b) is more or less volatile than the index. This gives you four possible outcomes.

If you are underperforming the index and are more volatile, the strategy is wrong so you should liquidate and just buy the index, as no amount of tax efficiency or lower costs on direct share holdings can compensate for a poorly performing and risky portfolio. If the portfolio underperforms the index and is less volatile, you should also consider liquidation; low volatility may allow you to sleep easier at night but it is difficult to see why you would keep investing each month in poorly performing portfolio. However, if the savings in lower costs and tax efficiency were such as to compensate over time for the poorer performance it might just be worth it. (Assuming you cost your time in maintaining the portfolio at zero).

If you have a return equal to or greater than the index but with higher volatility, you need to base future buy / sell decisions not alone on maintaining the fixed-percentage allocation but also on lowering volatility while maintaining performance, as you are carrying risk for which you are not being rewarded. If, of course, your initial strategy has resulted in a portfolio that both outperforms the index and also has lower volatility, you’re on the pig’s back, and are now probably earning big bucks in Wall St. and not wasting your time contributing to this forum.

So, of the four possible outcomes, Ronaldo’s (or indeed anybody else’s) direct share purchase strategy is really worth following only if it delivers a portfolio that outperforms the index with the same volatility (or matches the index but with a lower volatility).

If it slightly underperforms the Eurostoxx50 with lower volatility it might be worth doing it, if over time: (a) the lower costs involved in direct share ownership less the taxes to be paid on dividends and disposals compensated for the underperformance; or (b) if the strategy after costs outperformed an ETF or tracker when their costs are taken into account. (Or you could lower volatility, if this is what worries you, by buying the Eurostoxx50 and diversifying by also buying a low or uncorrelated index).

In all other underperformance cases you are better off just buying the Eurostoxx50, either via an ETF or a low-cost tracker.

 

[ronaldo]

Ronaldo: I think you need to benchmark your portfolio against the Eurostoxx50, i.e. calculate its percentage gain / loss and volatility (i.e. std. deviation).

I think this is over-complicating things. Basically, I'm just selecting the top twenty European shares with a maximum of two in any sector. The calculating percentages isn't even really necessary and could be left out of the strategy by simply buying an equal value of each share.

The purpose of the strategy is to provide an easy way (without delving into company books or technical analysis) of building a diversified portfolio of shares which can be bought and sold in a tax efficient manner and results in less commissions/taxes than a truly passive product such as a Unit Linked Fund. It is not to track the Eurostoxx 50 or any other index.

 

[howdydoo]

As I mentioned before, timing is everything. The past few weeks have been a heck of a ride down. But I wouldn't call this a bear market just yet until it's confirmed. Only now, it's considered a correction (although some for panicking more than normal like it is a beginning of one).

If the market cannot take it higher than the last high, we may be seeing a possible bear market starting, that test could be weeks or more away. Stay tuned...

[broken link removed]

One last thing, prices drop faster than they rise (hence, the reason why bear markets are shorter but deadly in percentage in loss). I think tracking a major stock index is the best way to determine if a portfolio can beat it or not. If not, then ride with it, a simple basket of stocks to own in one instrument.

 

[ronaldo]

I've got some inheritence money coming shortly which I'd like to invest. I'm thinking about a slight change to the above. I've looked at the 30 Shares in the Eurostoxx Dividend 30 - as I'd like high dividend payers.

I'd also like to automate my sharedealing to start with so that I don't have to spend too much time at it until I've enough invested to make it worth my while doing additional research, i.e. the way I see it, as long as I'm well diversified, I'll place my faith in the efficient market hypothesis to begin with and assume that all the shares are fairly priced.

Therefore, I've made a list of the 30 shares in the Eurostoxx Dividend 30 and the sectors to which they belong. It is heavily weighted towards banks and telecoms. However, as suggested above, I've set a rule that I must own a maximum of two shares in each sector and must purchase 15 shares from the 30. This should achieve the diversification I need.

I've ruled out Irish shares (of which there are 4) as my job is based here and I don't want my investments reliant on the Irish economy too.

I've listed the 30 shares in order of their weightings in the Eurostoxx Dividend 30 and am going to start at the top and purchase each share (provided I don't already have two in that sector) on the way down until I have 15 shares whilst avoiding the Irish shares.

This means that I will have shares in 15 companies that make up 58% of the Eurostoxx Dividend 30. However, unlike my previous posts, I think I might just buy an equal amount in each share.

I have opened a Interactive Brokers account and plan to lodge €2,000 of the inheritence money with them and the other €10,000 in Rabodirect. Interactive Brokers charge €4 per trade with a minimum monthly charge of $10 (close to €8). Therefore, to minimise my commisions, I'm going to purchase 2 shares per month for 8 months. This will have the added bonus of achieving dollar cost averaging. I will purchase €1,000 in each of 2 companies every month and transfer €2,000 from Rabodirect to Interactive Brokers each month to finance this. The money will only last for 12 companies so, during this time (6 months), I'll also need to save up €3,000 or €500 per month.

In the end, I should have €1,000 in each of 15 companies. I will then continue to lodge €500 per month to Interactive Brokers which I plan to use to purchase shares in the two lowest valued companies, i.e. the companies whos shares have either dropped the most in value or risen the least in value - this will achieve the buy low-sell high to a certain extent.

The shares I would own would be as follows:

2 Telecoms
2 Banks
2 Utilities
2 Retailers
2 Property
1 Oil and Gas Producer
1 Chemical Company
1 Steel Company
1 Machinery Manufacturer
1 Diversified Company

Therefore, I'd be limiting my exposure to any individual sector to 13%. They would also be diversified geographically throughout Europe. After a year or 18 months, I'll probably then consider investing in shares in other countries where there is a currency risk such as the UK and US.

As you can see from my previous posts, I've put alot of effort into deciding how to invest before I start but I have to start when I get this money because I'd planned to start over a year ago but never got around to it. Once I start, I'll have the discipline to stick to the budget I've developed instead of living from paycheck to paycheck.

If I manage the above, I'll have €18,000 invested within a year. This is equivelant to $24,550. Interactive brokers will be charging me $10 per month or $120 per year. Therefore, I'll have an annual management charge of 0.49% which will be reducing as I continue to invest.

This means that I'll be paying half the management charge I'd be paying with Quinn and I'll be able to choose my own level of diversification (most of Quinns trackers offer less than what I'd consider necessary). I'd also not have to deal with the 8-year rule and would only need to deal with taxes when I come to sell shares which I'd only plan to do in the most extreme circumstances.

 

[ShaneMc]

I'd also not have to deal with the 8-year rule and would only need to deal with taxes when I come to sell shares which I'd only plan to do in the most extreme circumstances.

You'd have to pay taxes annually on the dividends. Tax on foreign dividends can be quite messy.

 

[ClubMan]

I'd also not have to deal with the 8-year rule and would only need to deal with taxes when I come to sell shares which I'd only plan to do in the most extreme circumstances.

Just curious - towards what ultimate end(s) are you investing this money?

 

[ronaldo]

You'd have to pay taxes annually on the dividends. Tax on foreign dividends can be quite messy.

Whilst it's true that you have to pay tax and you will probably need to get an accountant or someone with experience in investing in European markets to begin with to help you file your first tax return, after the first years tax return, you'll know exactly how to deal with the issues. Either way, with the new 8-year rule, it will be impossible to merely invest in funds and have the investment company handle your tax returns anyway so why not learn now?

Just curious - towards what ultimate end(s) are you investing this money?

Basically, I'm 24 years old and between me and my employer, we contribute 15% to my pension. I have no debt and I own a site outright on which I plan to build a house. My dad is a developer and so I can get this done very cheaply in Donegal. I can get a mortgage using the site as security and the final LTV will probably be in the 50-60% region. I plan to start the build in about a year.

Whilst it could make more economic sense to save additional money for the house in a deposit account, I have made the personal desicion that I'd rather invest. I'm young, very interested in finance and willing to take risks. It would even be okay for me to have an interest only mortgage for a while as the LTV will be so low or I could even put off building the house for a few years if the market happened to dip at the worst time for me.

My personal plan is to go interest only with the mortgage and continue to invest. I will proceed with this unless sharp rises in interest rates or drops in house prices change my plans.

I don't know the plan for the actual investment proceeds. Possibly starting a business 5-10 years down the line or paying off my mortgage. I just feel that I can get a better return than that of my mortgage interest rate. It's true that I'll have to pay tax on dividends but I'm a lower rate tax-payer. It's also true that I'll have capital gains tax to deal with but I have a capital gains tax allowance to alleviate some of this. Also, my TRS relief will make my mortgage loan rate even cheaper.

 

[ClubMan]

Basically, I'm 24 years old and between me and my employer, we contribute 15% to my pension.

...

It's true that I'll have to pay tax on dividends but I'm a lower rate tax-payer.

Does it make sense for you to be maximising your pension contributions in this case? Some people are of the opinion that it may not.

It's also true that I'll have capital gains tax to deal with but I have a capital gains tax allowance to alleviate some of this.

Just €1,270 p.a. which is not that much (i.e. worth €254 p.a. into your hand).

Also, my TRS relief will make my mortgage loan rate even cheaper.

Presumably you know that your relief will be a maximum of €8K @ 20% = €1,600 p.a.

 

[Bez]

15% betwen employee and employer is not maximising contributions (unless it is a PRSA).

 

[ClubMan]

15% betwen employee and employer is not maximising contributions (unless it is a PRSA).

OK - does the original poster feel that contributing the amount outlined is the best option given the circumstances?

 

[ronaldo]

Does it make sense for you to be maximising your pension contributions in this case? Some people are of the opinion that it may not.

I didn't mention this previously because this is where it gets complicated. Whilst I'm a lower rate tax payer, I work in the north and live in the south of Ireland. My pension works through what is called a salary sacrafice scheme which basically means that I pay pension contributions before tax AND national insurance. Also, the company makes national insurance savings and they pay this into the plan. In the end, my total relief is 40% whilst it would be about 46% when I'm a higher rate payer. With regards to the comments highlighting the fact that I'm not paying the full allowable amount to the pension, the rules in the North allow me to contribute up to 100% of my salary so I have to draw the line somewhere. After the company pays their National Insurance savings into the plan, it works out at around 16% of gross salary thats paid into the plan which I feel is sufficient.

Just €1,270 p.a. which is not that much (i.e. worth €254 p.a. into your hand).

It's true that it's not much but, when starting out, I don't see myself selling any more than one share in a particular year (if even). Therefore, I'm allowed to gain €1,270 on that particular share. If I assume that the price has risen, for example, 20%, that means that, unless I own more than €6,350 of that particular share, I will have no CGT to pay.

Presumably you know that your relief will be a maximum of €8K @ 20% = €1,600 p.a.

Yes I'm aware of that. I've worked out that, using NIB's tracker rate, if I have a mortgage of 50% LTV or less, the rate will be 4.5% which will allow me a mortgage of €178,000 with full TRS. My mortgage will be well below this. I'm aware that, after 6 years, the TRS will be reduced to €3,000 which will allow for a mortgage of €67,000. In this case, I could consider selling my shares and paying my mortgage down to that level. However, TRS is not the reason for taking the above strategy. It's merely a facter that adds another advantage to the strategy.

 

[Guest127]

didnt make a bad job of predicting if you ask me. I agree with CM on the cgt issue though. its complicated enough as it is. even simple shares like vodaphone have an uk deduction and still subject to tax here , most likely at 41%. whats the point in avoiding tax on selling shares that make good gains anyway. looks like the ultimate aim is to die very wealthy but most people don't think that way.

 

[shanegl]

My reading of the situation tells me that while there may be plans to include them, the 8 year rule does not currently apply to domestic or offshore funds. If anyone can quote me legislation that says otherwise, go right ahead.

If you read the prospectus of the iShares DJ Euro STOXX 50 ETF, which is an Irish UCITS, you'll note that the fund will deduct any income tax payable from dividends or gains on encashment, leaving the investor with no further liability (unless there is an FX gain) (page 33). The 8 year rule is not mentioned.

[broken link removed]

This is dated 2006.

The 2007 Finance Act does mention bringing offshore funds under the "gross roll-up" taxation regime, but this isn't the same as the deemed disposal arrangement for the Life funds:

Section 39 amends the taxation rules in relation to offshore funds that are created under the law of EU and EEA Member States and certain OECD countries. These funds are covered by the ''gross roll up'' taxation regime introduced in the Finance Act 2001. This regime was brought in to match a similar regime for collective funds in the State that was put in place in 2000. Under gross roll up, funds may accumulate without the imposition of tax. However, an exit tax applies when payments are received from the fund or when there is the disposal of an interest in the fund.

That quote was taken from the revenue website:

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As far as I'm concerned, I'll be investing in such ETFs to avail of lower charges compared to Quinn etc., if they do eventually bring in a deemed disposal rule, so be it, I don't have the time to deal with the hassle of direct share ownership.

 

[maturin]

shanegl,

Here's an extract from the iShares Prospectus dated 4 December 2007. See:

[broken link removed]

This piece refers to funds which are UCITS registered in Ireland.

+++
Shareholders who are Irish Residents or Irish Ordinary Residents

Unless a Shareholder is an Exempted Irish Investor (as defined above), makes a Relevant Declaration to that
effect and the Company is not in possession of any information which would reasonably suggest that the
information contained therein is no longer materially correct, or unless the shares are purchased by the Courts
Service, tax at the standard rate of income tax (currently 20%) will be required to be deducted by the Company
from a distribution made annually or at more frequent intervals to a Shareholder who is Irish Resident or Irish
Ordinary Resident. Similarly, tax at the standard rate plus 3% (i.e. currently 23%) will have to be deducted by
the Company on any other distribution or gain arising to the Shareholder (other than an Exempted Irish Investor
who has made a Relevant Declaration) on an encashment, redemption, or transfer of shares by a Shareholder
who is Irish Resident or Irish Ordinary Resident. Tax will also have to be deducted in respect of Shares held at
the end of a Relevant Period (in respect of any excess in value of the cost of the relevant Shares) to the extent
that the Shareholder is Irish Resident or Ordinary Resident and is not an Exempted Irish Investor who has made
a Relevant Declaration. However, the Company will be exempt from making tax deductions in respect of
distributions and gains on redemptions, cancellations, transfers or encashments of shares held by Irish Residents
and Irish Ordinary Residents where the relevant shares are held in the CREST System or any other “recognised
clearing system” designated by the Irish Revenue Commissioners.
---
In the same document “Relevant Period” is defined as follows:

“Relevant Period” means a period of 8 years beginning with the acquisition of a Share by a Shareholder and
each subsequent period of 8 years beginning immediately after the preceding period.

My reading (and I'm no tax expert) is that the 8 year rule does apply to iShares ETFs registered in Ireland.

regards,
M.

 

[shanegl]

Yep, took me a few reads to get my head around it but it looks like you're right.