ETF 101

Welcome back RIPvestors, time has come to get back to my investment series.

We’re going to cover the very large ETFs world in this post, the preferred mustachians instrument to join the stocks party!

Disclaimer: I’m not an expert on this subject. I’m here to share what I know with you, my novice reader, since I think it’s more than enough to get started with ETFs. I’m here to learn more on ETFs from you, my dear expert reader, so that I can improve my knowledge and act better.

Another Disclaimer: I’ll run a simulation and finally pick an ETF at the end of this post. I’m not affiliate to the financial institution emitting the ETF. I actually own ~100k USD in shares of this ETF, so it’s a product I recommend because I’ve direct experience with it. I’m not here to sell you something!

Intro

Hey RIP, what’s an ETF?

Hello friend, long time no see!

We’ve seen in a previous post what generic investment funds are and the difference between actively and passively managed and how we should aim to invest into passively managed ones.

We’re going to explore here the Fund Structure, i.e. how the fund capitalization is collected, how profits are distributed and how shares of the fund are traded. We’re going to explore 2 different fund structures: ETF and Mutual Funds.

A possible structure is the following: you want to join the fund, decide which amount you want to invest on it, deposit the amount to your fund account and then you own a fraction of it. The total fund capitalization increases when new investors join. This extra money is used by the fund manager (or by the algorithm) to buy new assets according to the fund strategy. If you want to disinvest, the fund manager is forced to buy back the number of shares you want to disinvest at its current market value. The total fund capitalization decreases when investors quit. It means the fund may need to sell assets to pay back the quitting investors. This is the common pattern of Mutual Funds.

Another fund structure that’s getting every year more popular is the Exchange Traded Funds. ETFs capitalization respects the closed-end model, meaning that no money flows in or out of the fund once created – with some exceptions (accumulating funds). So at creation time the fund size is defined and so is the individual share size. Shares are then traded on stock exchanges like regular stocks. Initially all the shares are held by the institution who issued the fund (the trust company).

An ETF can be liquidated, which means:

  • the trust company sells all the assets
  • each shareholder redeems their shares
  • the fund then disappears.

Let’s make an example: I want to create an ETF with 100,000 CHF of capitalization and shares of 10 CHF, an unrealistically small fund. My fund will than have 10,000 shares initially worth 10 CHF. No matter how many investors will come and go, the fund will always have 10,000 shares.

My fund invests on stocks of italian companies that produces Mozzarella. With a capitalization of 100K we buy 1K shares of MammaBuona, 30 CHF each, and 1K shares of PizzaBella, 70 CHF each.

The day after buying the stocks, MammaBuona performed great and their share is now worth 40 while PizzaBella performed poorly and its share is worth 50. Total value of the fund portfolio is not 90K and so each share is now worth 9.

Wait, RIP, what does it mean that ‘a share is worth 9’? Aren’t they traded like regular stocks? So they are not strictly bound to their basket value… they may go crazy due to other factors, like normal supply/demand. is it correct?

Good point. Here things become a little bit obscure to me. You’re technically right, things traded on a stock exchange can go crazy. Let’s say your fund management skills demonstrated you beat the market everytime, then investors may be willing to pay more than the market value of the assets in your basket, since you’ll surely beat the market again. I lack knowledge here. Wikipedia explain that: “The ability to purchase and redeem creation units gives ETFs an arbitrage mechanism intended to minimize the potential deviation between the market price and the net asset value of ETF shares“. So let’s set this problem aside for a while. Well, let’s say for ever, I won’t come back on this.

“Ok, cool, but why do you advice ETFs and not Mutual Funds?”

That’s just personal taste. In US they love MFs slightly more. They have Vanguard, which is the best mutual fund company ever. Accessing Vanguard funds from Europe is more complicated and has financial implications (US Estate Tax, US dividend withholding…)

I personally prefer ETFs over MFs for the following reason: MFs bind you to a specific financial institution, while ETFs don’t. They may change their trading fees, they may go bankrupt, they may do aggressive marketing and force you to open other financial instruments with them (like bank accounts, credit cards…). Every bank has their “awesome funds you should buy” and a cool financial advisor that “works in your best interests“.

ETFs are kind of open source. Once they lift off they require less management (no external cash flow to handle) so it’s easier to make them passively managed, getting in/out is instant and cheap and they usually have lower Total Expense Ratio (TER). You don’t need to join any bank, you just need a broker to access the stock exchange(s) where the ETF is traded. ETFs are rapidly becoming the de facto standard for low cost fund investing, i.e. passively managed index funds.

Some may argue trading ETFs has 2 points of failure instead of one: the broker and the trust company managing the fund. My reply is that both have few (zero?) connections with the fund managed assets. And the closed-end structure cuts off some of the malicious strategies like Ponzi / Madoff schemes.

For the sake of completeness, here‘s a good article about why invest in Mutual Funds instead of ETFs.

Ok, cool, please RIP tell me more about stocks ETFs

Sure. We’ve previously discussed why you want to track Stock Indexes and why you want to differentiate among them. I’ve also disclosed my Asset Allocation so you know which indexes I want to track.

ETFs are tools to make your strategy happen, they are not a substitute for your strategy.

…Or are they?

Ok, let’s digress a little bit on the cost/control spectrum, i.e. how to implement your diversification strategy among the stock component of your portfolio. Usually delegating control (simplifying) comes at a cost. You could:

  • Buy individual stocks, and manually diversify. Total control, low maintenance costs. Well, costs may not be very low since you might end up frequently trading low volume stocks to rebalance your portfolio incurring in high trade fees.
  • Buy N funds that track stock market indexes and keep their value balanced (according to your strategy). You may hold a US S&P 500 Fund, a Europe Stoxx600, an Emerging Market, a Pacific… and rebalance yearly/by-quarterly/quarterly/monthly. Minimal costs, good control.
  • Buy a single World fund that tracks the entire world market, like the MSCI World Index or FTSE RAFI All-World 3000. A fund tracking such indexes keep self balancing to reflect world market capitalization and – in each market – to reflect company capitalization. Can be seen as a “fund of funds”. Given the slightly more complex behavior, usually world ETFs have higher costs (TER), in the order of 0.2 – 0.3 vs <0.1 of funds that track geographic (US, EU…) stock indexes. So, higher costs but less control. You may even buy more World funds to avoid keeping all your eggs into one basket, where the basket is the trust company managing the fund. You may even open more brokerage accounts to hedge against points of failure…
  • Use a Robo-advisor. Robo-advisors are (Wikipedia): “a class of financial adviser that provide financial advice or portfolio management online with minimal human intervention“. Essentially they are bots that keep your assets balanced, buying and selling shares on your behalf, according to a strategy. You throw money on your account and your robo-advisor knows how to allocate it. You want to withdraw from your account and your robo-advisor decides what to sell. This service comes at a price on top of the funds’ TERs. Here‘s a good US-centric article about robo-advisors. Popular robo-advisors are: Betterment, WealthfrontTruewealth (available in Switzerland). We’re not going deep there for now. Check out this MMM post about Betterment, this TSD post about Wealthfront and this JLCollins post about Vanguard for more info. Even higher costs, zero control.

I know people who operates at each level of this spectrum. Personally I adopt the “Buy N funds” approach. Minimal complexity and minimal costs.

Now we can finally dive into the mechanic of a single ETF tracking a single Stock Market index.

Is that all you can do with stocks? I heard about High Frequency Trading, Option Writing, Dividend Growth Investing…

Sure, there are countless opportunities, I know. It’s just that I’m a novice investor and all my limited knowledge is about long term investing on Stock Market Indexes. I don’t care about speculative high risk short term investments, I’m not a daytrader and I don’t wont to become one.

I’m both curious and suspicious about long term optimality of Dividend Growth Investing though. DGI means holding stocks of companies who have a long track record of having emitted constantly growing dividends over time. Here‘s an amazing introductory article on apathyends blog. Other excellent articles here and here. The good of DGI is that it’s a passive revenue stream without you having to touch the principal. The bad is that a company that issues growing dividends over time limits their potential long term growth. It’s not a coincidence that the strongest companies on the market today don’t issue dividends. Anyway, let’s just not waste time here to discuss this.

Wait, why just stocks? Why not go for angel investing, estates, precious metals, cryptocurrencies…

Wait wait wait, let’s step back. First you do your homework by asking yourself the following questions:

Q: What are your financial goals? Why are you investing? Short term? Long term?
(Mr RIP) A: I want to to reach FI and would like to live off of my portfolio profits forever.

Q: When will you need your money back? How much risk and volatility can you handle?
A: Ideally I’ll die at incredibly old age with my money still invested. I still need to be able to periodically withdraw something from my assets (ore use dividends/interests/profits). I can accept high volatility on a portion of my assets, given higher expected returns.

Q: What you feel comfortable investing in?
A: Nice question, thanks for asking 🙂 Well, this requires more space and time to elaborate, take a look at my IPS. Tl;dr: my AA (Asset Allocation) cover all the risk/reward spectrum, from super safe no reward (cash) to low risk low reward (bonds), average risk high reward (stocks) and potentially, in future very high risk high reward (angel investing / startups).

Q: Do you understand your investments?
A: Yes, I know the products I’m investing in, I’m in control of my portfolio. I made my investment choices and I’m ready to adapt them given new evidences. I know the risks. What I don’t know yet is my reaction if (when) things will go south. Will I be able to not panic? Life will tell.

Ok, ok, I got it. But I also heard of Small Cap, Large Cap, Tech, Finance, Banking and a lot of other sectors that have indexes. How am I suppose to pick my indexes? Just by geographic ares?

That’s a very personal question. Each one has their own taste and want to place their bets. My personal opinion is that sector-specific investments are inferior differentiation techniques – but I invest in a US Tech ETF, home biases die hard – while market capitalization categories are good tools to differentiate in risks/reward. Historically small caps have better returns but higher volatility. I differentiate among Large-Mid-Small Europe and Large-Small US.

Ok, let’s get back on track. You know your goals, you control your Asset Allocation and time’s finally come to pick the right ETFs to implement (part of) your strategy.

(continue on next page)

My Investor Policy Statement

Hi RIP friends,

Facilitated by some recent extra time purchases, as promised to myself (and publicly committed), I’ve finally allocated time last weekend to redact my IPS.

image: physicianonfire

What’s an IPS? IPS stays for Investor Policy Statement, essentially an investing guideline you define for yourself that helps keeping you on path when situations may trigger your instincts. The market crashes? You have a money surplus? You’re having kids? You lost your job? They say this year Emerging Markets will rock? What did you write in your IPS for those cases?

I wanted to write it down after having read this amazing post on PhysicianOnFire several months ago. I strongly recommend you write your own if you’re going to invest money (and you should). Btw, invest 5 minutes of your precious time and go read PoF post.

One of the first rule of investing is “define your goals, priorities and strategies”, that’s almost all an IPS is about. The level of details of your IPS should match your desired complexity level. A too detailed IPS may end up being edited too frequently or going soon out of sync with reality. A too generic IPS is mostly worthless. I use the CV rule: it should never be longer than 3 pages.

In writing your IPS you’ll be challenged to think about your values, your long term strategy and your exit strategy. You’re forced to ask yourself if you really understand what you’re investing in and why you’re investing in such categories and specific assets. You may start researching and gathering more information, refining your asset allocation and diversification strategies and, if you’re a nerd like me, you end up engineering your lifelong economic algorithm.

I chose to make mine a little bit longer than I’m comfortable with (whaaat? 5 pages??), since I wanted to embed in it my FIRE algorithm too.

Enjoy!


Mr. RIP Investor Policy Statement

Terminology
NW = Net Worth
WR = Withdraw Rate
SR = Saving Rate
FU = Target NW to call it FI

Objectives

  • Reach FI (NW >= FU) before age 45, i.e. before year 2022.
    • FU = 30x yearly expenses (desired WR = 3.33%).
    • Yearly expenses to be estimated not based on current ones but considering factors like: 1) moving out of Switzerland 2) having 1-2 kids 3) buying or not a house.
    • Once FI is reached, Yearly expenses (thus FU) updated each year based on forecasts and actual spending.
  • Reach 150% FU before age 50.
  • Stay above 80% FU forever, after having reached FI.

Overall Strategy

  • Hard Accumulation” phase while NW < 100% FU.
    • Save at least 50% of income (SR >= 50%).
    • Save at least 50k EUR each year.
    • It’s ok to not go beyond if it would impact well being (80% or even 60% is ok if previous 2 conditions are met).
  • Self Sustainability” phase while 80% FU < NW < 120% FU.
    • SR >= 0% – Don’t touch the principal, keep working sporadically or find other ways to bring money at home to cover for expenses and let the principal grow.
    • Note that between 80% and 100% there’s a so called hysteresis: keep behaving according to the rules in current state.
    • Below 80% (Oh Crap percentage – cit LivingAFI) restart accumulating (probably via frugality and hustling more).
    • Below 60% (Oh Shit percentage) get back to work unless some form of social security is triggered or I am above conventional retirement age.
  • What’s income?” phase while NW >= 120% FU.
    • make all work and income decisions as if the wage were 0 – cit MMM.
    • Stop caring about having to earn money, It’s ok to withdraw from the principal.
    • Stay in this phase while NW > 100% FU (hysteresis between 100% and 120%).
  • What’s money?” phase while NW >= 200% FU.
    • make all spending decisions as if the price were 0 – cit MMM.
    • Stop caring about budgeting, expenses, earnings. Just avoid plain stupidity.
    • Stay in this phase while NW > 150% FU (hysteresis between 150% and 200%).
    • Note that the FU% will decrease if yearly expenses increase.

Investment Philosophy

  • Invest mainly in stocks (>50%), secondary in bonds (<30%), maybe real estates (<15%), might consider p2p lending or angel investing.
  • Max out stocks investment at 100% FU. If my asset allocation says 60% stocks, once that 60% NW = FU (NW = 166% FU) then don’t over-invest in stocks, take extra money out of market ready to be reinvested in case of market drop.
  • Buy and hold stocks strategy.
    • stay invested (extra invest if possible) if the market crashes.
  • Stay low on costs in the “costs vs efforts” spectrum.
    • No individual stock picking (super low costs, high effort).
    • Yes Manually diversificate among regional Index Based ETFs: US, Europe, Emerging, Pacific (low costs, medium effort).
    • No world ETFs (medium costs, low effort).
    • No robo-adviser (high costs, zero effort).
  • Avoid investing in specific sectors (like “travel”, “consumer goods”, “technology”, “banks”).
  • Accept territorial home bias, i.e. invest heavily in the market where I live.
    • To keep up with local currency inflation and economic situation.
  • Avoid professional home bias while in accumulation phase (avoid “tech” investments).
    • To diversificate, i.e. avoid making a tech industry crash a double loss.
  • Optimize for tax efficiency over small variations (<0.2%) of costs (TER).
  • Prefer Distributing over Accumulating ETFs given same costs and tax conditions.
  • Don’t do DCA (JL Collins).
  • During accumulation phase, keep investing each month.
    • Use the monthly investing to rebalance.
    • Keep track of real vs ideal for each asset and throw money to assets that need the most.
    • To reduce investing trade costs, define an investing quantum and never invest amounts smaller than the quantum.
    • Forego monthly investment to cover large expenses (travel, vehicles…).
  • Once every 6 months do a major rebalance between asset classes and within each class.
    • Keep in mind the “no stocks above 100% FU” rule (and that 100% FU changes over time since actual yearly expenses and forecasts change).
    • Use this major rebalance to review this doc and eventually improve/change it.

Asset Allocation

  • 60% Stocks
    • 25% – Europe Large/Mid/Small (STOXX600).
    • 25% – US Stocks: 20% Large (S&P500), 5% Small.
    • 5% – Pacific.
    • 5% – Emerging Markets.
    • I allow myself to go on a slightly different route while in accumulation phase.
  • 25% Bonds
    • Pension Pillars (once left Switzerland these will disappear).
    • Government & Corporate Bonds (mainly local market).
  • 15% Real Estate
    • Primary residence.
    • Eventual rental properties.

Cash

  • Keep 2-6 months of living expenses in cash while working.
  • Keep 12-24 months of living expenses in cash while not working.
    • Consider cash an asset class that needs to be rebalanced every major cycle.
  • In case of urgent need of cash in bear market, sell bonds first.

Other Considerations

  • While in Switzerland, maximise tax deductions via Pillar 3a and Pillar 2a buy-ins.
    • Check the cantonal limit up to which a Pillar 2 buy in is not locked for 3 years.
  • Don’t take into account social security and pensions at regular retirement age.
  • Don’t take into account expected inheritance.

Supporting Family Members

  • Support eventual children.
    • Pay for their education till Master’s Degree.
    • Don’t give them paychecks but make them work for the household and earn money.
    • Teach them financial skills (spend less, earn more, be frugal, save, invest, be free).
    • Encourage them to be independent and leave the nest as early as possible.
  • Support other family members (parents, siblings).

Preparing my finances for my expected death

  • Aim to leave a significant portion of inheritance for a greater good.
    • Angel investing.
    • Charities.
    • Projects I care about (going to Mars?).
  • Aim to leave enough to my children and eventual surviving spouse.

Preparing my finances for my unexpected death

  • Make a will to make sure my assets are handled as I wish.
  • Have a life insurance after work’s one will expire to make sure my family won’t have financial issues.

Open problems

  • Given that most probably we’ll retire in Italy, understand investments opportunities and tax implications there.
    • Check income, dividends, capital gain and wealth taxes.
    • Check rental properties business.
    • Check freelancing / launching a company complexity and costs.

since this post won’t be edited much while my IPS will, I’m linking here a live version in Google Docs for those who want to follow how my IPS is changing over time. Here’s the link.

What are you waiting for?

Go write your IPS!

Market timing and US election

Good Evening RIP friends,

Did you sell all your stock funds? You know that doomsday is coming, don’t you? What are you waiting for??

Let me explain it clear:

  • aryaelectionIf Ronald Drumpf wins, the market is going to crash because he’s insane and none will invest in US.
  • If Hilarious Clinton wins, the market is going to crash because she will tax companies and rich people so that none will invest in US.

Clear, right? S&P 500 is currently overpriced!

Go!

Sell everything!!

It’s obviously an ingenuous lie. Market price already contains this information.

Uh, RIP, you made my heart skip a beat! So the election won’t change my fund value?

Oh no no no, it will surely be hit! It’s just that you don’t know in which direction. And you can bet that the expected value after the election – given all other conditions stay the same – is the current fund’s value.

I’m confused…

Let’s do some math: let’s assume a share of your S&P500 fund is priced 100. Let’s assume the market expectation in case of victory of candidate X is +10%, i.e price would jump at 110 per share. Let’s also assume that in case of victory of candidate Y the market expectation is -20%, i.e. a price of 80 per share. If your price today is 100 it means that there’s a 66% probability that candidate X will win against 33% of Y. Today’s value is the expected value.

If tomorrow a new poll says odds of winning are 60% for X vs 40% for Y and market expectations in case of victory of X or Y are the same +10% and -20%, then the new share price will drop to 98, which is the new expected value (110 * 0.6 + 80 * 0.4).

If, instead, odds of winning for X and Y stay the same but candidate Y announced a new wall on the Canadian border, bringing market expectation in case of victory to -30% instead of -20%, new expected value for the share is 96.666 (110 * 0.666 + 70 * 0.333).

What? Is it really so easy for a candidate to make the market drop?

That’s just a simplification. I hope that in case of such a claim the odds of winning for Y would drop and expected value for your share would actually increase in this scenario. Another level of simplification is that market doesn’t just react on what candidates say. That’s just propaganda. It reacts on true well founded hypothesis on what would happen in case of victory of X or Y. Who’s funding their campaigns, which kind of lobbies they have behind and so on. Market is more stable than our fears.

And don’t confuse expected percentage with chance of winning. Today polls say 48% vs 43% (and 9% third parties) while odds are 86% vs 14% (and 0 third parties).

So… should I sell?

As I’ve already said, trading has costs. By trading a lot you’re expected to lose money, unless you’ve some kind of knowledge that’s not publicly available. Otherwise, selling is just an expensive bet. A less-than-zero sum game. Not selling is a better bet. A more-than-zero sum game.

Like any normal day in the market.

P.S. here some nice stats about historical market performance based on candidate’s party and here the same concept expressed by Trent Hamm in 20 words, while I needed more than 500…

Investor Profile and Lifelong Investing Strategy

Good morning RIPvestors,

welcome to another post in the investing series, where I gradually introduce you to the world of investments and go deep on topics I have some experience with, mainly related to investments in Switzerland.

Here’s the tentative schedule for the series:

  • Investing basics – Easy
  • Financial Investing – Easy
  • Funds Investing – Easy
  • Fees & Taxes – Medium
  • Stock Price and Market Model – Hard
  • Investor Profile and Lifelong Investing Strategy – Medium (This Post 🙂)
  • ETF 101Hard
  • Interactive Brokers 101 – Hard (coming soon)
  • My Investing Strategy – Whatever (coming soon)
  • “Uncharted territory”:
    • maybe a post about degrowth and how to reconcile capitalism and anti consumerism
    • maybe other socioeconomic posts I don’t know yet
    • maybe a post about investing in yourself

[Note: schedule changes with every new post. Please refer to the latest post in the series for a more up to date schedule.]

In this post we’re going to talk about… ouch, I forgot what we’ve seen so far!

RIP, I’ve been following you throughout the series. We’ve seen all the basics and I’m ready to invest my money! I know that I should keep some money cash, something between 3-12 months of living expenses. Then invest the rest. Some on bonds and some on stocks. Index funds more than individual stocks, to differentiate and reduce risks associated with individual stocks. I know that fees matter a lot, so I should shop for a cheap broker. I also know that I should invest as soon as possible and stay in the market for as long as possible… I’m not sure I fully understood that btw… Anyway, a lot of theory but I don’t know how to convert it into some concrete steps…

Ok, cool. Thanks for the recap! Well, brace yourself: we’re going to see something concrete here!

Yeeeah! So? How should I invest? Which actual assets should I buy? Which bank/broker should I use? When should I buy/sell??

warrenbuff11Relax, calm down. Not yet, not all together. Here we’re going to devise a plan for your lifelong investing strategy. We’re not going to look at what you should actually invest into (btw, we’ve gone very deep there, you should tell me on what to invest right now) and not even which bank/broker services to use. Just how to design your support infrastructure.

Did you do your homework? Did you write your IPS? Do you have an assets allocation strategy? If not, go and come back once you’ve done with that.

Ok, welcome back!

swissflagDisclaimer: my view is biased toward Switzerland in several aspects:

  • No capital gain tax, but wealth tax.
  • Tax deferred accounts (Pension Pillars) essentially not investable but they don’t matter for wealth tax.
  • Investments are funded mostly with after tax money.

Ok, let’s move on! I assume you’ve your asset allocation strategy.

Well RIP… yes, I do. I’ve put 10K cash and the rest 75% Stocks and 25% Bonds… is that ok? Is that anything else I should invest in?

Cool! Well done! You asking me if you should invest in something else? Let’s face this soon so we can move on quickly. I don’t know. Surprise! I don’t really know. It depends on your personal taste, on your investor profile and on the amount of time you’re willing to spend to become an expert in a field.

Your investor profile, according with Wikipedia:

An investor profile or defines an individual’s preferences in investment decisions, for example: Short term trading (active management) or long term holding (buy and hold) Risk-averse or risk tolerant / seeker. All classes of assets or just one (stocks for example)

Your investor profile defines what kind of investor you are. Please, take time to assess it. Don’t invest mindlessly, be sure to have your investments and your strategy aligned with your profile. There are people who invest in safer assets like structured notes. There are investors who invest in precious metals and mining companies and those who invest in options (it’s kind of meta investing). There are literally plenty of “paper assets” types. You’ll find people who recommend X over Y all the time. I do recommend stock funds that track market indexes (and bond funds, eventually, for bonds). Because they are better? No, because they are simpler. You don’t need to know much to jump in. We already covered all you need to know to avoid panicking, trying to be smart and trying to time the market. So the bottom line on this is: if you really want to spend your time and energy on other investment areas, please do. I’m just here to show you a simple strategy that worked well enough in the last 150 years of recorded financial history.

Back to us: you’d like to invest 75% of your current investable NW (your NW minus cash/emergency fund). Before moving on, let’s split your financially aware life in few ages:

  • The first investment time. Here you probably are, my friend. You have some savings and want to start investing them and you don’t know how, on what, when, what to do if you lose money,…
  • The income (or accumulation) age. Here’s where I am. You are investing and still earning a salary, you’re saving and you want to invest what’s left each month (or spend what’s left after investments).
  • The transition age. Your investments are producing enough money but you’re not FI yet. You may want to take a sabbatical, switch to part time, take some risks in new activities or careers or simply follow your passions being aware that this may reduce your earnings. Here you probably can manage to keep your expenses below your earnings but you won’t be investing much more. Maybe you even need to withdraw a little from your invested capital. I will explore this sooner or later, since I may actually take this path.
  • The withdraw age. You’re living off of your investments, you’re FI (and retired). You need to withdraw continuously to support your expenses.

I assume you’re either in the “first investment” time of your life or in the income phase, i.e. you’re still working, earning, spending and saving at least 25% of your earnings, possibly 50% or more (what about 80%?) which means you want to invest every month a good portion of your savings, am I right? Awesome!

You wrote your IPS, so you probably have your guideline written down and your differentiation strategy, am I right? Not yet? Listen… take your time and do something like this:

assetsalloc

Here you can see an example market analysis and diversification strategy. On the first two columns you can see the indexes and their descriptions. This is just a screenshot, the original document (that I’ll clean and share sooner or later) contains links to justetf, a popular funds search engine where I do all of my researches. Third column is the target percentage of my investable NW. As you see not all the indexes made it. But it’s good to spend a little time researching indexes, markets and sectors. You don’t do this very frequently, just every once in a while. Let’s assume the whole Travel industry collapses, then you probably want to remove the Travel index from this list!

Wow RIP, what a deep analysis… do I need to do the same? And btw, what are those strange codes in columns 5-9?

No, you don’t have to do such an analysis. I did for… fun! Well, I wanted to know what’s around to differentiate more than I do today. These percentages are WIP and subject to change. I remember to have signed off to provide my IPS by end of year (update: here you go), I still have time 🙂

Anyway, you’ll probably be ok investing in few indexes like… wait, that’s your job! I can’t help you in this. Find your differentiation strategy and come back. If you want to keep as simple as possible, find a WORLD index and go all-in with it. Vanguard has total market fund. Sadly, Vanguard in Switzerland is slightly harder to manage thus they are not so recommended. We’ll cover it later in this series.

Ah, and those strange codes are ISIN, a.k.a. International Securities Identification Number. Identification numbers for your funds. Just don’t care about that for now (psst… those are actual funds!).

Now you have your assets allocation strategy! What’s next? Oh right, buying actual funds! There are several funds type, and for each index you want to have in your portfolio, there are tons of funds that track it. We will cover the problem “how to chose a fund, given an index I want to have in my portfolio” in another post in this series, so please let’s assume for now that you already have a preferred fund for each of your indexes.

[Note: you can even diversify within the index and buy several funds that track the same index. I don’t know if that’s useful. My personal opinion is that it is not. Plus it complicates things at tax time. The more asset you have, the more complex your system will be.]

So now you have your funds list each one with its desired target percent of your investable NW. cool! Let’s put that into a spreadsheet:

invsts

Note: previous screenshot is my new (WIP) strategy, while this one shows current strategy. Refactoring in progress.

Here you can see few things: current allocation, target and delta for each asset class and within stocks funds (ETFs, we’ll learn more about them in another post) allocation by index. If you’re curious, I’ve explained a little bit about this structure in a previous post.

How does this spreadsheet work? How can it help me during my entire life? The schema we’re looking at easily supports income age (as well as first investment time), let me show you how.

You can monitor your desired allocation among funds and your actual investments. In case you’re at the first investment time all the actual would be zero. You periodically take a look at the deltas and if they are greater than a certain threshold, you act on it. Either buy buying more of asset X or selling asset Y. For example, according to the old plan, I’m short of STOXX 600 Europe fund by 37K. I should buy 37K of that fund. I’m investing 33K too much in S&P 500 Tech Cap, so I should sell it.

This way you can monitor diversification. The system is also self balancing: if a fund grows too much and sooner it will dominate your portfolio, you sell a portion of it to rebalance and achieve the planned diversification. If a fund loses too much to go below its target, you buy more of it. This way you also “buy low and sell high” automatically.

Why did I mention a threshold? Because in doing that I’m trying to minimize frictions: if my broker charges me 10 CHF minimum trade fee or 0.1% of the trade value, I try to never buy/sell less than 10K, to avoid paying fees at a higher percentage. So I don’t act on deltas smaller than 10K.

How frequently to buy/sell? Don’t get obsessed by it, you only need to take a look once a month o once everytime your accumulated savings are above the threshold. So, only you know when to look at it. If you save 500 a month and the threshold is 2K you go looking once every 4 months. In any case, better to not let more than 6 months pass, else your portfolio may become unbalanced on its own.

Cool RIP, so everytime I have new savings all my deltas will grow… once I have 10K (or the fee-based threshold) available, I’ll throw them at the asset with the bigger delta!

Yes, you got it right! You’ll find that in this accumulation phase you won’t need to sell, since even if an asset performs very well, your overall NW is going to increase, leaving you with smaller deltas and a cash surplus.

Ok RIP… so I’m essentially NEVER selling my stocks, am I right?

That’s not totally true, you’re going to switch from “accumulation phase” to “withdrawing phase“. Eventually transitioning to intermediate phases, in case you’ll reduce working time or switch to a semi retirement.

Ok RIP, I mean I’m not going to buy and sell frequently. I have friends who do that. I know you already told me it’s not the right way to go… but this friend of mine says he makes Godzillions…

Ok, let’s clarify this once and for all: there’s no right and wrong. I showed you how it’s hard to be smarter than the market, but you’re free to try and you may actually succeed! You may have better intuition than the investors crowd. You may bet on the oil price going up, or on banks going up, or on tech going down or whatever. If your guesses are right, you may be rewarded by tons of money. Go for it! The way I see it is like gambling, but in case you buy/sell frequently you’re paying a lot of trade fees that will make the expected return lower than just following the crowd. Thanks to trading fees, if you do a lot of operations with expected zero impact you’re losing money. It’s like betting on red or black on the roulette without considering the green number zero.

That’s because my investor profile is different that your friends one. I’m a Buy & Hold investor, while your friend is probably a Day Trader. The day trader’s job is to beat the market and perform better than average. The buy and hold investor is ok with matching the market. The first is driven by short term gains, while the second prefer to play on long terms.

bhvsdt
image: http://www.edelmanfinancial.com/

I’m kind of Risk Averse, while your friend may be more Risk Tolerant. I’m a Fund investor, your friend may be a individual  stocks investor (or, as we’ve seen before, an investor focused on other asset types). Different people, different profiles. Seek out yours! Write it down in your IPS.

Cool… then, what to do when in withdraw phase?? I’ll soon be FIREd and living off of my investments, how to handle withdraws?

Nice question! I have no idea 😛 I’m not there yet so I’m not the best person to ask. But let’s try to figure this out together: in withdraw phase you probably want to reduce stocks exposure over time. You will probably change your investor profile becoming more risk averse. You should continually change asset category allocation and experience deltas changing. You act accordingly. I don’t see a big difference here. You may try to switch to distributing funds instead of accumulating, so you have the dividend in hands instead of having it automatically reinvested – so you can disinvest it.

I have another idea that involves defining your “Stocks FU Number“, a desired total invested amount in terms of number of years of expenses (say 20x). If you’re lucky and your investments grow above 110% of that, you disinvest the extra 10% and buy more bonds. If it gets below 90% you take the missing 10% from bonds and invest them in stocks. This way you can reduce market collapse risks and you have a clear signal that you need to go back to work: when you hit the 90% and have no reserve.

But I still have plenty of time to tune my strategy!

Last but not least: Dividends.

In this very long post I talked a lot about stocks but almost never introduced the concept of dividend. A dividend is a tool companies use to redistribute profits to the shareholders. You own a stock of a company the day the dividend is distributed, you get the money. Some companies don’t distribute dividends by choice. I don’t like to focus on dividends since they are mostly neutral factors in stock decision for me (but need to tell there are investors who love dividend stocks: 1, 2, 3). Actually, from a company point of view issuing a dividend is a damage in the long term. Let me explain: when a company issue a dividend of X per share, the stock price instantly loses X. It’s logical, the company is worth less. If a company doesn’t issue dividends, the not issued dividend is still in the stock price. A company that reinvest the not issued dividend is more likely to make more money out of it, with a final result of having more chances of growth in the future. There’s more value in stocks who don’t distribute dividends. Here’s a list of very successful and growing companies who don’t distribute dividends.

Have a nice day.

Stock Price and Market Model

Good morning RIPvestors,

welcome to another post in the investing series, where I gradually introduce you to the world of investments and go deep on topics I have some experience with, mainly related to investments in Switzerland.

Here’s the tentative schedule for the series:

[Note: this post is split in several pages because it ended up being very long.]

In this post I’m going to show you my understanding of the stock market and the players involved. My humble goal here – I’m totally NOT an expert this field – is to help you (and myself) in becoming aware of the risks associated with investing in stocks/funds, understanding the basic mechanics behind a stock’s price and avoid common pitfalls like panicking and trying to time the market.

astrobeerEssentially I’m going to throw a lot of mostly useless words at you that probably won’t impact much your behavior as investor. Sadly though, in the world of “risky” investments even few apparently small mistakes can destroy an otherwise good strategy. For that reason – to avoid disasters and better react to bad news – I think it’s useful to build a solid knowledge base. For the same reason astronauts spend more than 90% of their training time facing simulated disasters. The difference here though is that I’m not as good as the thousandth part of an astronauts’ trainer 🙂

Hi RIP, I’m a little bit lost. I’m following you since the first episode and my mood is continuously flipping between enthusiasm and desperation… Can you just tell me how, when, where, on what should I invest??

Relax my imaginary friend, there’s still a long way to go. My goal, by the end of this post, is that you’ll know as much as I am and you’re going to tell me what I should invest into. The rest of the series is just technicalities to implement your strategy. Here we’re going to dig as deep as I’m able to into the realm of the market rules.

Let’s start with the single most important thing to know, and let’s do that by asking a question: What’s in a stock price?

I think it should be intuitively clear why this is the single most important piece of knowledge about the stock market, but let’s assume it’s not. If you understand why a company is evaluated at X and what you’re paying when you buy it, you’d recognize all logical fallacies when taking impulsive decisions. Bullshits like: “everyone should buy X, they are growing a lot!“, “Emerging Markets didn’t grow in last 6 years, you shouldn’t buy” or “The market is high, you should sell” should ring a bell inside you.

So then, what’s in a stock price? Or in general, what’s in a price of anything sufficiently traded in free market model? I said “sufficiently traded” because if the market is not wide you may experience under/over pricing due to lack of knowledge by some of the traders.

In the stock price of a company X in a free and wide enough market is the averaged risk adjusted opportunity cost of the flow of X’s expected returns over time.

What a complex definition! And I made it! It’s mine, mine! Let’s dig deeper.

magicstoneLet’s start with an example: “I want to sell you this Stone. This Stone will produce, out of thin air, 10 Dollars per day. Inflation adjusted, Forever“. How much would you pay for the magic Stone? Let’s for simplicity assume that the 10 dollars per day are the only asset we’ll be owning and that we can’t make any other business decision like trying to become famous by showing to the world that we own a magic object (how cool would it be??).

There’s not a unique answer to this question. But to try to come up with a price I’d do the following analysis: how much would I need to obtain the same cash flow with another known investment strategy? That’s my individual opportunity cost. Let’s assume I’m risk averse, so my default strategy with my money is buying bonds and I’m looking for better alternatives, whatever gives me more than the very low at the moment bonds’ returns. Another potential buyer may be less interested, since they may be running a nice business where every extra dollar they invest on it doubles every year. This potential buyer will be willing to pay less for the Stone, since they need less dollars than me to obtain the same cash flow. Their opportunity cost is higher. If you have a wide market, the opportunity costs eventually reach an equilibrium so do the prices.

Opportunity costs play the stabilizing role of inserting a nice negative feedback loop into the price of everything. If there’s an economic boom and everything is growing 20% each year my opportunity cost is very high so I’m willing to pay less for things. The opposite happens on recessions.

Such a Stone is a good model for a treasury bond, not for a stock. Expected company revenues are harder to predict (mean estimation) and yield very high uncertainty in the prediction itself (variance estimation). The means may drive the price, the variance may alter the opportunity cost. One thing is to have a guaranteed and predictable cash flow over time, another thing is to have a lot of unknowns. Would you rather buy X that earns 5% guaranteed per year or Y that is expected to earn on average 5% per year but may go up and down by up to 90%? Right, volatility comes with a cost. That’s why I added “risk adjusted” component into the price. That’s why you may get a predictable 2% from bonds but expect 6-10% returns (averaged per year over a very long period of time) from the riskier stock market.

Anyway, setting aside opportunity costs and the risk component (variance) the most problematic variables left in our price definition are the unknown expected returns over time.

Here’s where all the magic happens. Why a stock’s price bumps by +-10% after a political news, a quarterly earning disclosure, a company acquisitions, a government maneuver? Well, because the expected returns of the company over time change.

And btw, expected by whom? This is another individual factor. You can try to make your offer for buying a stock based on your personal expectations. It won’t impact the market price though. If your offer is below the market price, none would sell you. If it’s above everyone would buy from you. So what’s the market price? It’s the equilibrium. It’s the average expectations of future returns. It reflects the expected returns over time of the company, expected by the very large population of buyers and sellers. Expected by all the publicly available information about the company, the sector it operates in, the rumors about acquisitions, the hire rate, layoffs, current and past earnings, newspaper headlines, current and future projects… the price of a stock of a company contains the expectations of its future, based on all the publicly available information.

Well, I’m using the word “stock” where I should use “capitalization“, which is stock price multiplied by number of circulating stocks. Not a big issue, the same concept applies. I’m also focusing on stocks instead of index funds but the same rules apply. An index fund in just an aggregation of stocks.

So, let’s say once again, since this is the basic rule of everything about stocks: the stock price of a company embeds the expectations of its future returns, based on all the publicly available information.

“Ah cool… anyway, RIP, when is my stock price raising?

Essentially, it is raising when today’s expectations are better than yesterday’s. Well, not exactly. Meeting expectations should earn you the risk adjusted opportunity cost. In an age where in US people wonders if you should take 5%, someone else aims to 3x risk free guaranteed returns of 2% (i.e. 6%) of a balanced portfolio with other assets categories represented along with stocks, I guess that 6-8% per year is a valid expectation those days, for investments in USD currency at current inflation rate (~1%). In Euro area, with inflation rate close to zero, expected returns may be 5-7% in EUR currency.

Anyway, it’s important to understand that it’s not enough that the company you’re investing in is doing well, it has to do better than expected (or at least as good as expected). This is true in the other directions. If a company is expected to shrink, it may still be worth investing in it. The price already reflects bad expectations and just keeping up or shrinking less than expected may end up in a stock price increase!

Let’s take a look a the implications of this rule:

(click on Next Page)

Fees and Taxes

Good morning RIPvestors,

welcome to another post in the investing series, where I gradually introduce you to the world of investments and go deep on topics I have some experience with, mainly related to investments in Switzerland.

Here are other articles published in this series:

In this post I’m going to show you the importance of fees and taxes in investments, with a focus on Switzerland brokers fees. We’re not going to take a deep look at assets related fees since my only experience is with funds’ fees – and we’ll take a look at that in one of the following posts in this series.

In the previous post I left you with a lot of unanswered questions. Sadly we’re going to answer to almost none of them in this post, just throwing a lot of confusion (read: data and pessimism) on the table.

Oh, finally RIP… I was waiting for this series to continue! What’s next? I heard that MyCoolIndex went up X% last year, if I invested back then and sold everything today now I’d have X% more, what a shame!

That’s sadly not true my imaginary friend, and that’s what we’re going to talk about today: actual investing will bring you slightly less money than theoretically expected, due to some kind of second principle of thermodynamic applied to investments. Like friction slows everything down and generates heat, every time you move a Dollar you experience financial friction and your money evaporates into nothing. Well, not exactly into “nothing”, but into someone else’s hands. Sadly, frictions in finance are everywhere, not just on money movements. They take several names, mainly taxes and fees. Taxes are on wealth (nominal value of your assets) and/or profits (dividends, capital gain) so they are there to smoothen the good news: reducing the gains. Fees are there anyway, as permanent bad news.

Before moving on, please read deeply this article by The Simple Dollar on the math behind fees compounding. Essentially, even a small difference of decimal percent points between recurrent fees will lead to gigantic absolute differences if given sufficient time. Here‘s another detailed article if you want to know more.

Ok, let’s take a look at fees and taxes.

Fees

feezInvesting is not a zero sum game. It’s not but due to two opposite factors:

  • it’s a less than zero sum game, since every action has a cost/fee.
  • it’s a greather than zero sum game since economy grows over time and everyone win.

We covered the expected greater than zero (I hope) so far in this series. Here let’s focus on the costs, the frictions, the energy loss due to transactions and managements.

We agreed you shouldn’t buy shares of an actively managed fund, right? Anyway, passively managed funds have costs. Usually they are costs proportional to the invested capital and to the number and volumes of transactions.

Brokers/banks may charge you for the custody of your securities. Depending on what you invest on (banks usually offer you discounted fees if invest in the funds they manage), you may incur in:

Account opening/closing fees.

Say you want to start investing and don’t know what to do. You find a mediator (a bank, a broker service, a financial institution, the government,…) and want to use them as a tool to buy, sell and hold your assets. You probably need to open an account with them. This operation alone may have costs and/or other kind of requirements like, for example, you may also need to open a checking account with the same bank, you may need minimum initial deposit, you may be forced to accept an expensive initial consultation with a physical person to assess your risk tolerance, et cetera.

perpetualmotionSame is true for closing the account. Please double check before opening an account with them. Must say that these kind of entry barriers are not very popular, since everybody wants to have you in with them.

I’ve also heard you can get “credits” for opening a brokerage account with some firms. I’ve not found yet someone who did it Not in Switzerland though. We use to respect thermodynamic principles. There are referral bonuses though. Like my favorite broker firm does! Note that the above link is not a referral link (yet), just a link to the referral program.

In the long term, opening/closing fees are negligible anyway since they are only paid once.

Deposit/withdraw fees

Your brokerage account is like a virtual world where you buy and sell things which reflects on moving number in databases. On its own, it’s an interesting world. But you probably want to connect it to the real world, where real money moves around. To do so you must be able to deposit money into your account and to withdraw from it whenever needed. Another source of friction.

On top of that you may need to take into account money transfer fees at source. Real case scenario: you have a bank account with bank X, you want to transfer money to entity Y that handles your investments. You instruct bank X to wire a certain amount of money to entity Y. Both X and Y may charge you for this.

I’ve actually found firms that issue a deposit bonus (as always, not in Switzerland), like forexbroker – well, forget about that: after a very deep 10 seconds research I’ve found it’s considered a mostly scammy broker.

Usually deposits are not charged by the entity Y (they want you to deposit money) but your bank X may apply transfer fees. I’m lucky enough that CHF deposits from my “CH – CHF – Individual – checking” account (row 19 on my NW) are not being charged, despite the bank and the underlying broker bank account for CHF deposits are in different nations (CH vs UK). Sadly, USD deposits from my “CH – USD – Individual” account (raw 23, different bank in CH) to the underlying broker bank account for USD deposits (which is in US) are charged a little by the CH bank.

Same is not true for withdraws. Here X and Y goals are reverted. Y doesn’t want you to take money out. For instance, with interactivebrokers, (a.k.a. IB) I get a free withdraw per calendar month, then each subsequent withdraw is charged with a flat rate of 11 CHF at the moment (September 2016).

Anyway, even though these fees can be somewhat recurrent (you want to deposit/withdraw with a higher frequency compared to opening/closing accounts) in the long term they don’t mind too.

Yearly custody fees

Here’s the first fee that matters a lot!

Custody fees are usually proportional to the invested capital and are paid out yearly or quarterly. They are in the range 0 – 1% of the invested capital. 0% is very rare, the only broker I’ve found that offer such a good deal in Switzerland is again IB, but you need to have invested at least 100K USD or else you’ll pay 10 USD per month.

Custody fees are strong forces that accumulates over time and cost you a big chunk of your invested capital. Again, let’s skip the math here and please take a look at this article on how a 1% fee will eat 25% of your investments in 40 years, or play yourself with this Investment Fee Calculator.

If you choose your bank as investment broker, you’ll probably discover that they have 2 separate custody fees: a higher one (0.5 – 1.0%) for holding your generic securities and a lower one (0 – 0.5%) for holding securities issued by them. It’s a scam, run away! Their securities are managed funds with obscure – but high – management costs. I’ve chatted with both UBS and Credit Suisse and they are similar in this. Last time I chatted with UBS they had a quarterly fee of 0.14% (and somewhere around 0.04% quarterly for UBS managed assets) but at the time of writing they changed it to annual model, with a 0.35% base fee that can grow till 0.75% for non traditional funds outside Switzerland. 50% discount for UBS issued assets (which are in Switzerland and are not non-traditional funds, so 0.17%). Here‘s the link to the up to date information. Scam anyway.

Same holds true for Credit Suisse, even though their fees seem slightly lower.

If you plan to be a long term investor (and we’ll see why you should in next episode), choose a broker that applies the lowest custody fees.

Trade fees

So far you opened a broker account with entity Y and wired some money over. It’s time to buy securities! Is that free of charge? Of course not! Each trade has some friction in the range 0.05% – 3% of the value traded, sometimes with lower/upper barrier fees.

Yes, I’ve seen 3% trade fees at UBS for pension Pillar 3a funds like Vitainvest 25. Note: they state in the bullet points list under “Your benefits” the fact that the fund has an “Active management” so that “the weighting is always in line with the latest market forecasts”… wow thanks a lot UBS, I’m so lucky to have this team of financial expert to help me managing a fund that should simply match a Swiss Market Index like SMI or SPI with 25% of its capital and invest the rest in a Swiss Bond Index (SBI).

My experience, again, is with IB that has a dual trade fee model: Fixed vs Tiered. I actually don’t understand in which cases the Fixed model is better, because to me it seems the Tiered model is always better. Anyway, if you know a use case when Fixed is better, please write it down in the comment section of this post.

The IB Tiered model charges 0.08% of the trade value, assuming we are all trading less than a million CHF at a time. 0.08% – or as seen sometimes 8 basis points – means 8 CHF for a trade of 10K CHF. Fair enough. There’s a minimum of 1.50 CHF per trade, which means trading less than 1875 CHF in a single transaction ends up being more expensive.

Trade fees are relevant, you’re going to trade a little bit over time. Anyway, as we’ll see in next episode, if you’re a day trader you care more about these fees than if you are a buy&hold investor, like you should.

Premium fees

Brokers offers a wide variety of services and premiums you can benefit from. Do you want real time stock exchange data instead of 15 minutes delayed? If you wonder why it matters, maybe you’ve never heard about high frequency trading. Well, actually the high frequency guys don’t use a broker, they interact directly with the stock exchange. Anyway, if you are a day trader and want to make a fortune by timing the market and trading several times a day you may need better market data.

If you’re like me and don’t want to care about this stuff you don’t need any premium package.

Adviser fees

Are you managing your wealth or asking for help? This is not free. Advisers may eat another big chunk of your money via consulting and performance fees.

You should simply run away. No value added.

Funds management fees

Essentially, we can forget about minor fees like deposit/withdraw, open/close and premiums. Understanding custody and trade fees covers 95% of what you should really know about your broker. We’ve done with it.

Now it’s time to dig a little bit on fees related to the security you want to invest into. Note: I may use the words security or asset inconsistently across this series, but I mean the same thing. If I want to be specific I say stock, fund, bond,…

If you buy stocks, there are no other hidden costs. You follow the stock price on the internet (Yahoo Finance, Google Finance, your broker web/app interface) and that’s all. If you buy a fund, there are fund management costs. We’ve seen them in a previous post of this series and we said they strongly depend on the fund being actively or passively managed. Anyway, the fund management fee is never (as far as I know) paid out directly, but it’s withheld from the fund’s capitalization and reflected into the fund’s share price. It’s universally called Total Expense Ratio (TER). As we’ve seen it’s in the range 0.07 – 3%, yearly.

The TER is another fundamental number to try to keep as low as possible! Two funds who track the same index can be compared using their TER. The lowest, the better!

Always.

Well, it’s not true.

Why? Taxes…

Taxes

tazzesEssentially, taxes are other fees. Usually bigger fees. There are several kind of taxes on investments:

Wealth taxes

The concept is that you pay a yearly tax proportional to your NW. Proportional is not the correct word since, as every other tax does, the tax brackets are higher the higher your NW is. This is something new for me, since in Italy we don’t have a wealth tax (for now).

Sadly, Switzerland has a wealth tax that can reach 1%, yearly, of your wealth. Following this or this sources of information you can see that where I live (German speaking Switzerland, lower taxes) wealth tax for a NW of 1,000,000 CHF is between 0.1% and 0.4%.

Since, all your after-tax investments contribute to your wealth, you need to take this into account as an extra cost. Pension Pillar 2 & 3 don’t contribute to your wealth-taxable NW.

Dividend taxes

When companies distribute a dividend and you own stocks of that company, you earn the dividend. In almost any country the dividend is taxed either as income or separately. In Switzerland dividends are income. In Italy there’s a flat “financial return” tax bracket by financial asset category. Here‘s a link (in Italian) about rates. Currently, it’s 26% on stocks and funds.

Another problem is when the company is traded in a stock market in a different country respect your residence. Sometimes you may incur in double taxation. For example, US tax authority (IRS) withholds 15% of dividends, like a tax at source. If you’re Swiss resident and want to avoid problems you can use the DA-1 form to reclaim that tax.

Capital gain taxes

When you sell something that you paid less than that, you have a capital gain. This is taxed on several countries, like US and Italy. Luckily, Switzerland doesn’t have a capital gain tax. Italy has a flat 26% capital gain tax.

Lump Sum Taxes

In Switzerland – like in US – you may withdraw under certain circumstances (leaving the country, buying a house, starting a company) from your Pension Pillars 2 & 3. When you do, you pay taxes on it since your Pillars are pre-tax money. Luckily, you don’t pay full income tax but a fraction of it. You can calculate how much you would pay withdrawing from your Canton using this calculator, and then check how much you would pay withdrawing from Schwyz Canton clicking here. Note: you can always move your assets to another Canton before withdraw.

Anyway, if you invest your Pillar 3 (I’m not aware of investment opportunities for Pillar 2) you need to take into account these extra taxes you’re going to pay at withdrawal time. I’m accounting for this tax on my NW spreadsheet (row 58) with a tax rate of 5.3% which correspond to the expected rate in my Canton for the expected capital I’ll withdraw.

Trade Stamps

trading stocks on some stock market may incur in extra trade taxes. Trading stocks on the Swiss stock market as a Swiss resident you pay the Swiss stamp tax. I’m not aware about italian situation on this.

Costs (Taxes and Fees) Recap

As we’ve seen, all these fees and taxes will likely kill your strategy. The 4% rule is just a study based on S&P500 performance, assuming no fees and no taxes. Well, let’s say assuming no capital gain tax and gross withdraws. An ideal situation.

When planning for your actual situation you need to take these costs into account. What it means is usually a couple of things:

  • You may discover that your plan is not viable in your target country. In my case, Italy is not well suited for living off of investments thanks to too many taxes.
  • You may want to revisit your Withdrawal Rate, adding few safety margins. That’s why I’m not planning to go for a 4% but a 3.33% instead.

Open question: I didn’t find a nice non-standard retirement calculator for Switzerland/Italy. Kudos to who’ll point me to a suitable one 🙂

Now, back to your strategy my dear friend!

See you on next post on this series.

NW Spreadsheet improved – plus a taste of my current investment strategy

Hello friends,

I’ve updated my NW spreadsheet to include a NW tracker (historical too) and my real time portfolio allocation strategy and monitoring.

You’re obviously free to copy it out and personalize, or simply copy features and formulas you like.

Let’s take a look at each feature:

NW Tracking

This sheet tracks NW month by month, getting data from the NW sheet. Each color represent a currency: red is for Euro, green for USD and purple for CHF. Note that each light grey row is a jump of 5K in that currency 🙂

Data here are reported since May 2016, to better appreciate progresses during blogging time 😉

Historical NW

histnw

This sheet tracks my NW since the beginning of time. You may be interested in following the evolution of my NW thru the series My Financial and Professional Story so you won’t ask why there’s a 3.5 years hole in the data. Here each light grey row represents a jump of 10K in that currency.

Portfolio Allocation and Strategy

invest

This sheet is both defining my Portfolio allocation strategy (which is, btw, Work In progress) and my current real time assets allocation.

Disclaimer: I’m writing this article in September 2016. All references to columns, rows and cells are based on screenshots posted here. The underlying document will change over time but I don’t guarantee to keep information in this post in sync with the sheets evolution. Take the static images posted here as reference.

All values in this sheet are expressed in CHF.

The strategy is defined by column E. The 100% base is defined on the invested capital, which is not my NW. The invested capital is NW minus virtual money (credits), minus liabilities (debts), minus cash. The strategy defines which percentage of my invested capital is to be allocated on what.

Each row represent an asset category into which I want to allocate money. There are estates, bonds and stocks. Current coarse grain strategy is 15%, 25%, 60%. The stocks category is split in 3 index funds

Plus 3% of fun money to invest in random individual stocks. I usually hold some Hooli stocks, but I allow myself to play a little bit with random stocks. Never done so far though.

I added the actual ISINs and Tickers of my funds (ETFs). More on this on its own post in the investing series.

Note that there’s no target percent for cash. I model cash needs as few months of salary worth into an emergency fund (or a collection of bank accounts). At the moment I’ve set 30K CHF as cash cushion target (cell H8).

Column G measures current realtime allocation and it’s based on values from the NW sheet. Note that the Total here (cell G9) doesn’t correspond to my current NW, as I explained before.

The Current % column (column F) tracks my current allocation of each asset category against my total. As you can notice the percentages don’t necessary sum up to 100%. If it’s more than 100%, it means I have less cash than the target. If it’s less it means I have more cash than planned. Right now it’s 95.6%, in fact I have 51K of cash. I said in last monthly financial update I need cash these days for extra expenditures so it’s all ok.

Column H is the absolute target on each asset category, obtained by multiplying the target% (column E) by my total minus target cash.

Column I tells me if I need to invest more (positive value, red color) or less (negative value, green color) on that asset category, and it will drive rebalancing.

Here’s the full document embedded in this post. Click here to see it in Google Sheets

Well, I lied about strategy being monitored in real time. I update this NW document once per month, copying data from my personal (not shared) NW document which is in real time. Sorry for that 🙂