Estimated net return from investing outside a pension fund

[Corola]

An Irish domiciled ETF tracking the FTSE All-World index will lose around 0.2%- 0.3%

That is on the high side, many providers have reduced their fees recently. Less than 0.2% is achievable for a global ETF.

The best World ETFs

The easiest way to invest in the global stock market is to invest in a broad market index. This can be done at low cost by using ETFs.

www.justetf.com

 

[Shannb1]

That is on the high side, many providers have reduced their fees recently. Less than 0.2% is achievable for a global ETF.

Sorry I was just estimating the tax drag which is a cost on on top of the charges (vs the index)

 

[ClubMan]

If they implied direct equity investment then wouldn't the charges be negligible? Certainly not €7,500 per year which 0.75% would be

Depends on how much trading they do and on what platform and what the fixed costs of said platform are?

If we say that the retail charges on both equities and bonds are 0.75% p.a. and ...

 

[Louisval]

Thanks for all the replies. I totally understand the reason why @Shannb1 mentioned ETFs and, again, his post has been very helpful.

I realise that I should have made something clearer earlier. Me bad. For now, I am looking at insured arrangements. This explains the 0.75% allowance for charges. I get it that ETFs are cheaper (and I may well revisit this later). So where am I going with the 33% tax charge then? The answer being that two financial advisers have told me that this is on its way. As I have to make some assumption as to the level of the tax in the future, I figure it's my best guess as to what tax rate to assume. (For avoidance of doubt, I know that nobody will be able to tell me the precise level of tax over each of the next 20 to 30 years!!)

So, let me summarise where I've got to:

In an insurance company type product, if we assume total charges of 0.75% and using a reputed resource to support our gross return assumption and an allowance for an improvement in the tax charge, we get to reasonable long-term return expectations for modelling purposes of:

Equities: (5.9% - 0.75% - 0.25%) * 2/3 = 3.27%
Bonds: (3.3% - 0.75%) * 2/3 = 1.67%
50/50 Equity/bond split = 2.47%
Inflation: 2%

I'm trying to work through my thinking here, step by step. Before moving on, do these return assumptions (net of taxes and charges) make sense for insurance company type products?

 

[Sarenco]

Those projections don’t look unreasonable to me (although I’m still struggling to see the point of this exercise).

 

[ClubMan]

For now, I am looking at insured arrangements.

What does this mean?

The answer being that two financial advisers have told me that this is on its way.

They can't/don't know that for sure.

As I have to make some assumption as to the level of the tax in the future, I figure it's my best guess as to what tax rate to assume.

If you're referring to ETFs then you can only work on the basis of how they are taxed right now and not in idle speculation about what might happen possibly years down the line.

In an insurance company type product

Again what do you mean? A unit linked fund/UCITS or the like? Or something else?

 

[Louisval]

Thanks again @Shannb1 - really appreciated.

As mentioned, I'm doing an exercise with/for a neurodivergent pal and I appreciate your support in helping me to work through his questions step by step in a methodology that makes sense to him.

As far as possible, he likes order and certainty and doesn't like surprises. Sure, this may well be true for many people but particularly so for him. He likes planning and he likes spreadsheets and the like.

Accordingly, he knows himself well enough to know that he just doesn't like the volatility inherent in shares. But he will invest in shares if convinced that so doing is a smart move. His next question is, broadly, as follows:

Is investing a substantial portion of one's "personal investment fund" in shares actually worth it when the majority of the ERP is not going to go to the investor but, instead, will be eaten up in taxes and charges? His sense is that the net reward is not really worth the grief of the additional uncertainty/risk/volatility - because the individual investor, in Ireland, doesn't capture enough of the reward. He makes the point that if he invests in a zero coupon Irish government bond, his return expectation may well be higher than a 50/50 equity/bond insured arrangement (........which may help to explain the thread to this point! and, by the way, he doesn't plan on lobbing everything into Irish bonds either - he gets the diversification thing!) [He arrived at this opinion himself based on the current 41% tax regime but even if we allow for an improved tax treatment, I'd be very interested (and appreciative) of whatever comments/insights you may have.........your comments, to date, have been very useful.]

 

[TomEdison]

Appetite for, or aversion to, volatility is a very personal thing. You can encourage him to be rational about this, and to consider that, with long term investments, short-term volatility is not a problem (or, at least, is a relatively small problem — a tail that should not wag the dog) but people's investment preferences are not entirely rational. If he would be freaked out by volatility, that's a consideration which may justify avoiding or minimising volatility. He doesn't want an investment that makes him permanently anxious.

There are investment products which provide a smoothed investment return — with-profits contracts, for example. The problem is that they're not very transparent; you know what the net return is. but it's hard to know what the gross return was, and how much was shaved off in taxes and charges along the way.

There may be a tension between (a) investing in a way that minimises taxes and charges; (b) investing in a way that maximises the expected net real return; and (c) avoiding volatility. Perhaps the best think you can do for your friend is to recognise that that tension exists, and help him to prioritise between these competing objectives, and work out what balance between them is optimal for him.

 

[Louisval]

Thanks @TomEdison - that's a very good summary of the competing objectives - invariably, with investments, some form of trade-off exists.

I suppose what I'm struggling with is the specific latest question posed whereby, outside of a pension fund in Ireland, the ERP really is more like ERpP in that one holds the equity risk but only enjoys part of the premium. This form of asymmetry reminds me of the dynamics at play for those with a DC pension fund who are likely to exceed the SFT and whether remaining in equities (in the lead up to retirement) is sensible for such investors when, again, the premium is subject to a punitive tax. In this later case, I've seen commentary* that extra risk is not adequately compensated. If this is true, to what extent does this apply to insured/pooling type equity investments outside of a pension that are subject to the, currently, 41% tax?

*The commentary I've seen, admittedly, predates the softening of the SFT regime but I think that the core point remains valid.

 

[ClubMan]

What's "ER[p]P" in this context?

Is investing a substantial portion of one's "personal investment fund" in shares actually worth it when the majority of the ERP is not going to go to the investor but, instead, will be eaten up in taxes and charges?

I suppose what I'm struggling with is the specific latest question posed whereby, outside of a pension fund in Ireland, the ERP really is more like ERpP in that one holds the equity risk but only enjoys part of the premium.

 

[Louisval]

Equity Risk partial Premium!!

 

[TomEdison]

I suppose what I'm struggling with is the specific latest question posed whereby, outside of a pension fund in Ireland, the ERP really is more like ERpP in that one holds the equity risk but only enjoys part of the premium.

I don't think this is unique to Ireland, or indeed to equities. Pretty much all countries tax investment returns.

Yes, this tend to narrow the gap between the the return on less risky cash/bonds investments and the return on more risky equity investments. On the other hand, this means that the risk premium which the more risky investments must offer to attract capital has to be high enough to attract that capital, despite the tax. Inother words, ERP is higher precisely because it's going to be taxed!

 

[ClubMan]

Yes, this tend to narrow the gap between the the return on less risky cash/bonds investments

Which are also generally subject to taxes on returns too?

 

[Shannb1]

I don't think this is unique to Ireland, or indeed to equities. Pretty much all countries tax investment returns.

But our tax regime for investment outside of pensions is harsher than most countries - CGT is higher, fund taxes are higher, deemed disposal, we don't have tax advantaged accounts (TFSA, ISA), dividend taxation is one of the highest in the OECD etc.

the risk premium which the more risky investments must offer to attract capital has to be high enough to attract that capital, despite the tax. Inother words, ERP is higher precisely because it's going to be taxed!

When we are talking about asset pricing of globally traded assets like this, the fact that a small number of buyers/sellers (irish taxable investors) are highly taxed isn't going to increase the risk premium. It just discourages investment in these assets by this cohort as the returns are not adequate compensation for the risk (as the OP is highlighting). So all other things being equal you might expect a higher amount of our investment to be in cash or domestic assets (property?) which have a level playing field from a tax perspective. Which I think is what we see in Ireland.

 

[TomEdison]

Which are also generally subject to taxes on returns too?

Yes, but the tax still narrows the gap.

Consider this hypothetical:

• Return on bonds 4%
• Return on equities 6%

In that case, the premium for investing in equities is 2%.

But now we add a 25% tax on investment earnings:

• Gross return on bonds 4%; after tax 3%
• Gross return on equities 6%; afer tax 4.5%

The premium for investing in equities is now reduced to 1.5%.

But our tax regime for investment outside of pensions is harsher than most countries - CGT is higher, fund taxes are higher, deemed disposal, we don't have tax advantaged accounts (TFSA, ISA), dividend taxation is one of the highest in the OECD etc.

A common impression, but I don't know how true it really is. It's formed by focussing on the taxes which are especially high in Ireland, while ignoring those which are especially low or are entirely absent, and by focussing on countries that have tax-advantaged investment accounts while ignoring those which don't, etc.

Here's a link to a paper that tries to take a more holistic view of capital taxation in various contries: https://taxfoundation.org/data/all/global/tax-burden-on-capital-income/

It looks at all the relevant taxes - corporation tax on gains, capital taxes, property tax, transaction taxes and (I suspect) considers not only the fact that e.g. Ireland doesn't have ISAs but also that it does have unusually generous pension fund tax concessions, etc, etc. Based on OECD data it's conclusion is that Ireland is actually at the lower end of the scale when it comes to the taxation of capital income. Obviously, this is an average and the situation of many individual investors may be far removed from that average, so they may face high tax rates on capital income, e.g, because they're not in a position to make use of pension fund tax concessions. But, overall, it doesn't support the view that Irish taxation of investment income is particularly harsh.

When we are talking about asset pricing of globally traded assets like this, the fact that a small number of buyers/sellers (irish taxable investors) are highly taxed isn't going to increase the risk premium.

Sure, but that's not my argument. Even if it's true that Ireland is taxes capital income higher than most countries, most counties do tax capital income. The risk premium that global equity markets offer has to reflect the fact that, globally, investors do pay a material amount of tax on their investment income.

 

[Shannb1]

Thanks for sharing this @TomEdison - this article measures the average tax burden on all capital income at an aggregate level, including corporate profits, property, and all forms of capital income. Their methodology doesn't specifically examine the retail investor experience.

A country can have relatively low overall capital taxation while still having specific investment vehicles or structures that are taxed unfavourably. Ireland fits this pattern - it has investor-friendly corporate taxation and some capital-friendly policies at the macro level, while simultaneously maintaining punitive rules for certain retail investments and products like dividends, ETFs and funds. My point is specifically that for retail investors investing outside of tax advantaged structure like a pension, we are relatively harshly treated, which is still true.

 

[Louisval]

Thanks again @TomEdison and @Shannb1

Rather than debate further the relativities of Ireland's taxation regime vis-a-vis other countries, I'd like to get back to Irish lad with a lump sum to invest please!

At what point do you believe the likely net reward for the retail lump sum investor is not sufficient compensation for the inherent volatility? I'll leave the question as general as that so that you can frame your answer as you wish.

 

[Sarenco]

Again, there is no “likely” return on equities over any time horizon.

Maybe you will observe an ERP over a particular time horizon. Or maybe you won’t.

Your framing of this issue makes no sense and therefore your theoretical question is pointless.

 

[Shannb1]

Unfortunately there isn't a single answer to this as retail lump sum investors are not a homogeneous group.

Personally I'm happy with putting money away for 10+ years, knowing that I won't need it during that period, hopefully won't check the performance too much (maybe I can't guarantee this one!) and in the knowledge that I won't get anxious or feel like selling even if we get a say 50% drawdown during the period. This steers me more towards 100% diversified equity investing at as low a cost as I can get. Over this time period I can be confident that I'll at least match inflation and hopefully do better.

In your specific case, they have to judge the tradeoffs themselves. We don't know enough about them & their financial position to say... but from what you have said it seems like the net reward doesn't feel worth it in this persons case and so I can understand if they stuck to short term cash or direct investment in government bonds and they should just about protect themselves from inflation.

 

[BIG-notorious]

At what point do you believe the likely net reward for the retail lump sum investor is not sufficient compensation for the inherent volatility?

At the point when the individual lump sum investor is not comfortable with the range of expected potential returns over the relevant investment period as compared to the reference stable return.

Say your reference stable investment is 2% annualised and guaranteed return. Your investment period is 10 years. Say your range of expected returns is 95% likely to fall between 1% and 11% with the median & average expected return being 6%.

If you think that means you should expect a 6% return, you're wrong. That's not how it works.

Everyone is comfortable with an 11% return or higher, and most people would be happy enough with 6% as well. But are you comfortable with a 1% annualised return? Or a 2% negative annualised return? Because 95% probability means precisely nothing to the 1 person in 20 who's part of the 5%.

If you're not comfortable with the worst case scenario keep your money in the bank.

If you can't just sit there and don't do something while the value of your investment plummets, keep your money in the bank- otherwise you'll likely sell low and buy high.

There's no likely net reward with equites. There's what you hope for and what you get. Hopefully you'll be satisfied with what get but you need to be able to live with it regardless.

Don't get me wrong, i love numbers and the median returns in particular are nailed into my planning figures (Brendan would call them excel fantasies but whatever). But I'm also very aware of the possibility of historically bad returns for the rest of my life so I've very much got a contingency plan that I can live with.