Hypothetical Situation: No Indices, No Rebalancing

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bostonimproper
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Hypothetical Situation: No Indices, No Rebalancing

Post by bostonimproper »

After talking to an accountant who specializes in Irish expat taxes, I've come to learn that my understanding of Irish tax law was off. Noting below the most important points as it may be useful to others in the future (+reminder that I myself am just a person on the internet and not a tax specialist):
  • Non-domiciled Irish residents (were not born in Ireland, father was not an Irish resident when you were born) do not have to pay taxes on investment gains that are not remitted to Ireland
  • ETF's in retirement accounts are shielded from deemed disposal, but you do pay income tax on withdrawals that are remitted.
  • US-domiciled ETF's are actually not subject to deemed disposal due to the way these ETF's are set up (i.e. non-institutional investors cannot convert to underlying units). As such they are actually the *best* thing to hold (as opposed to mutual funds).
  • Also Irish people are effectively barred from holding US ETFs, as in a custodian will drop you / freeze your account if they know you're residing in Ireland.
This all means that in our case, where we don't intend to use these funds, that we should make sure our brokerage funds are in US-domiciled ETFs and not mutual funds. If we do intend to use these funds, we should consider selling + rebuying for a stepped up basis when moving to Ireland.

---------

Background: We're moving to Ireland, which has a weird "deemed disposal" rule which is basically a 41% wealth tax on ETFs and mutual funds that hits every 8 years. Gains for ETFs are also taxed at 41% (versus 33% capital gains tax for other investment vehicles) and there's no such thing as tax loss harvesting for ETFs. We plan to come back to the US eventually and mostly just want to preserve our stash.

So here's the hypothetical situation:

Let's say you had to invest a sizable portion of your FI stash in such a way that for a period of exactly 8 years you are:
  • Not using ETF's.
  • Employing minimal-to-no rebalancing, and no fresh money coming in.
  • Track all-US stock market index performance.
What do you invest in and how?
Last edited by bostonimproper on Tue Dec 03, 2024 11:00 am, edited 4 times in total.

chenda
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by chenda »

Could you be a UK resident for tax purposes ? Live in Northern Ireland ?

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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by jacob »

With practically zero fees, you can build your own index. Given how unbalanced many of the more popular indices have becoming, you also don't need to buy all its components. For example, the 10 biggest components of NDAQ comprise more than half the index. If you buy the biggest 20, you're close to 75% tracking and that's ignoring all the correlations.

delay
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by delay »

AFAIK, if you are a US citizen and have investments in the US, you do not have to report your US investments to European tax officials.

bostonimproper
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by bostonimproper »

@chenda @delay We are moving with the purpose of getting me citizenship. Ireland tax is complicated re: whether our US investments are within their remit, but after 3 years we will have Irish ordinary residence and with the intention for citizenship it gets complicated fast.

@jacob My biggest concern is the hassle of buying individual stocks and tradeoff with being underweight small and midcaps. Do you happen to know of a retail service that allows to import bulk trades / some other short cut for broader exposure in case FAANGetc implode?

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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by jacob »

If FAANG implodes, the index will also implode. Index components are heavily correlated with the index itself and are therefore not good hiding places from movements of the index.

Having replicated an index myself (one that is not available as an ETF) I wouldn't say it's a big hassle. It's only 20-30 trades and trading is free these days. Insofar your index contains some requirement for internal rebalancing (mine does, the DJIA or the S&P500 or NASDAQ100 does not), it's possible to create a googlesheet that'll pull the prices from googlefinance. You can then make some buy/sell fields if a price band is exceeded.

chenda
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by chenda »

bostonimproper wrote:
Sun Nov 24, 2024 2:09 pm
@chenda @delay We are moving with the purpose of getting me citizenship.
Great, I hope it all goes smoothly and do ask if you want any recommendations.

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Sclass
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by Sclass »

I’m stunned that Ireland beats up on ETF and mutual fund holders so severely yet spares individual shareholders. I’m scratching my head wondering why? What is their logic? It reminds me of the U.S. where the IRS beats up the middle class wage earners (W2) severely yet spares the owner class. It seems that Ireland is hurting the shareholders who need the most help.

This Irish thing is like a wealth tax on the unwealthy.

I don’t think it is hard to roll your own. It’s not rocket science to create a sector table based on market caps on an index you’d like to mirror. Then fill a stock funnel with potential investments from each sector that you winnow down to fill each sector. Since the S&P is weighted a lot of your work is done for you by the big dogs like Jacob says. You don’t have to worry about the mid and small cap because they are mid and small cap weights. Two dozen issues maybe enough. Alternatively if you’re really lazy just read the public filings of Berkshire and copy them.

Personally I’m just an individual stock investor and I don’t pay attention to weighting. If I think something is going to go up I’ll buy a lot of it. If I think it’s is going to rise a little I buy less. I’d laugh at the Irish taxman and just do what I normally do. This does sound outrageous though as it hurts the middle class investors the most.

zbigi
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by zbigi »

Building your own ETF has the disadvantage of paying tax on every rebalancing. One can simulate (under certain assumptions) how much it will hurt and if it's better than buying a regular ETF.

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loutfard
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by loutfard »

You are aware of https://www.bogleheads.org/wiki/Investi ... xed_income right, and of the mention of https://www.trustnet.com/factsheets/t/f ... -trust-ord it makes?

P.S. Funnily enough, the situation over here is exactly the other way round. To avoid taxation, I _have to_ chose accumulating etf's over individual stock . Irish-domiciled accumulating etf's even.

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Sclass
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by Sclass »

I’m not sure what to think of rebalancing. I The OP says they don’t want that.

It made me wonder is rebalancing really a good thing? Selling winners to raise cash for losers?

I did a search for “(duh) is rebalancing good” and the AI summary says yup it’s good.

I’ve made a lot of money on a few stocks I let run for decades. And I’ve lost money on ones that shot up and flamed out early. Maybe the OP needs to create a portfolio like Berkshire where the underlying goal is to hold forever and just let good businesses keep being good businesses. Let the internal rate of return push stock valuations and defer long term capital gains. Then the question is how to select the shares.

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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by jacob »

Sclass wrote:
Mon Nov 25, 2024 8:22 am
I’ve made a lot of money on a few stocks I let run for decades. And I’ve lost money on ones that shot up and flamed out early. Maybe the OP needs to create a portfolio like Berkshire where the underlying goal is to hold forever and just let good businesses keep being good businesses. Let the internal rate of return push stock valuations and defer long term capital gains. Then the question is how to select the shares.
Rebalancing to extract value works for cyclical securities and the only securities that tend to be cyclical are entire asset classes. IOW rebalancing asset classes is a way of trading the business cycle without saying the T-word.

Rebalancing individual issues in an index is more dubious. Like you say, it's a way of taking profit but it also throws that profit at the losers. One could argue that the business cycle also happens within a stock index.

At this point rebalancing has practically become institutionalized. At the end of the month when paychecks roll in and "get automatically invested", retailers will log onto their accounts more or less within the same few days and hit the "rebalance button" thus pushing the same strategy on the market. As such, sectors that have gone up during the month will have selling pressure and vice versa. People think they're doing a smart academic thing but they're really acting as a herd and possibly getting front-run by 23 yo traders with degree from a "good university" and 2 years of experience in online poker.

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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by DutchGirl »

"At the end of the month when paychecks roll in " - Dutch people in general get their monthly paychecks around the 22nd to 24th of the month. Americans often get two paychecks per month, or one paycheck every two weeks... So I'm wondering whether the effect on ETF prices is really there? And if so, what days of the month see higher trading volumes (because of people getting their paychecks and sending some of that money to investments).

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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by jacob »

@Dutchgirl - It does require some time-series analysis and statistics to root it out but it's there. Volume will start ramping up before people get their paychecks as institutional money managers anticipate and prepare for this happening. Consider how much money actually needs to flow through the financial markets as 3-5% of an entire country's or world's paycheck income gets routed through with some going back out to the pensioners who need their investments turned into a monthly payout. Many funds are mandated not to exceed certain allocation thresholds. They have no choice but to trade.

bostonimproper
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by bostonimproper »

Sclass wrote:
Sun Nov 24, 2024 6:52 pm
This Irish thing is like a wealth tax on the unwealthy.
A lot of the Irish tax code seems like this, at least from my American perspective. 12.5% tax on corps whereas I'm facing a 51% marginal tax rate on earned income. No property tax though. Then there's this whole thing where they want to collect tax from you, even after you've left-- though I guess the US does that too, but the US has much lower taxes!

In terms of Berkshire matching, one thing I've learned is that BRK is actually quite popular in Ireland, because it is common stock so doesn't get hit by the deemed disposal rule. Again, can't make heads or tails sense of it all.

@loutfard I was not aware of those links, thank you! So does that mean for 36 bps I basically get something akin to QQQ, but whose value can be at significant discount or premium vs. underlying assets?

@Jacob Thanks, appreciate the perspective!

dulce
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by dulce »

jacob wrote:
Sun Nov 24, 2024 1:38 pm
With practically zero fees, you can build your own index. Given how unbalanced many of the more popular indices have becoming, you also don't need to buy all its components. For example, the 10 biggest components of NDAQ comprise more than half the index. If you buy the biggest 20, you're close to 75% tracking and that's ignoring all the correlations.
Just to add to this comment. While Index funds work well for people contributing to an IRA regularly in terms of simplicity, if you have a set amount of capital to deploy say $500,000 it would be very easy to just buy 100 stocks at a 1% allocation with no annual re-balancing. You could very easily just buy the 100 biggest market cap stocks in the USA and likely do very well with that. This type of portfolio actually exists. Look into the Voya Corporate Leaders Trust. https://individuals.voya.com/product/mu ... erformance Established in 1935, the fund bought a collection of blue chip stocks with the rule that no sales could be made even if a company was facing bankruptcy. It's returns have been very respectable.

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loutfard
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Re: Hypothetical Situation: No Indices, No Rebalancing

Post by loutfard »

bostonimproper wrote:
Wed Nov 27, 2024 3:07 pm
@loutfard I was not aware of those links, thank you! So does that mean for 36 bps I basically get something akin to QQQ, but whose value can be at significant discount or premium vs. underlying assets?
Sorry, I'm not intimately familiar with the intricacities of the Irish tax system. I mentioned this because I've found the bogleheads wiki to be very high quality on multiple occasions.

P.S. 51% marginal rate from 100k€ is certainly not the highest in northwestern Europe, especially with tax and social security charges combined. Belgium typically charges ~66.57% from 48.2k€:
- 50% federal personal income tax
- 7% (typical) local tax on the federal amount
- 13.07% employee side social security contribution (+25% employer side not added in)

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