One of the principles I followed when I first constructed (and in the ongoing maintenance of) my retirement investing low charge portfolio was to minimise fees and taxes. I do this as fees and taxes have a big effect on your final portfolio when investing over many years due to the compound interest effect as I demonstrated here.
So as a UK investor how does one do this? The obvious way is to buy the assets with as low a fee as possible which enables you to construct the desired asset allocation in your portfolio. Then you shelter your assets from tax in tax wrappers or tax deferral schemes which for UK investors could be pensions, individual savings accounts (ISA’s) or National Savings & Investments (NS&I) Index Linked Savings Certificates. Right? Well IMO not quite because that’s looking at 'fees or taxes'. I have just discovered a more subtle effect which could also affect me wgich demonstrates 'fees and taxes'.
I think this is best demonstrated with an example. As part of my low charge portfolio I want to hold 5% in emerging market equities and to minimise my fees I just want to track the market. To achieve this I am buying ETF’s (exchange traded funds). A quick web search for emerging market equity ETF’s will quickly reveal three possibilities. The:
- iShares MSCI Emerging Markets (IEEM) ETF which is domiciled in Ireland with a total expense ratio (TER) of 0.75%;
- db-xtrackers MSCI Emerging Markets Trn Index (XMEM) ETF which is domiciled in Luxembourg with a total expense ratio (TER) of 0.65%; and
- Lyxor MSCI Emerging Markets GBP (LEME) ETF which is domiciled in France with a total expense ratio (TER) of 0.65%.
So which do you choose? Well a quick look might have you flipping a coin and choosing either the db-xtrackers XMEM or Lyxor LEME ETF’s. However as the Financial Times reports you also have to be careful of tax with the ETF’s themselves. They say “ETFs domiciled in France are potentially the most disadvantageous for Britons. For example, the Lyxor FTSE 100 ETF is tax-resident in France, despite being listed on the London Stock Exchange, which means the French tax authorities deduct a 25 per cent withholding tax from dividend payments.” They go on to say that “double taxation agreements generally allow up to 15 per cent of foreign withholding tax to be credited against a UK tax liability...” however “the process is often so laborious it's impractical, unless your stockbroker can do so on your behalf.“ Importantly though “ Irish and Luxembourg-domiciled ETFs are the most tax-efficient for Britons as there's no dividend withholding tax, so the tax position is effectively the same as a UK-domiciled investment.”
So back to our emerging market equity ETF example and it would appear as though the decision is more than just flipping a coin. Of course this is just one element of an investment and there are many other risks that one should be aware of such as counter party risk to name but one example.
What this proves is that investing is not as simple as it might seem on occasion. It also shows why it’s important to always do your own research and engage help as appropriate.
As always DYOR.
Disclosure: My retirement investing low charge portfolio contains db x-trackers XMEM.