Index Investing Europe
In the FIRE community everyone invests in index funds.
‘Use an ultra-low-cost Vanguard Account to accumulate your index funds’. Thanks, good to know, but in Europe we don’t have access to Vanguard Accounts, no 401k’s, nor IRA’s, nor other US tax beneficial vehicles. What should I do in Europe? How to use an index as investment vehicle? What are the expenses? Which kinds of index thingies do you have, and which one to choose?
The index I want to own
For FIRE tribesmen and women, index investing is investing 101 stuff. You can find the basics in any FIRE blog.
My personal interest for this blog post is to research which funds would be accesible for me (in Europe / Belgium), which ones are best, and what to expect from them.
The indexes I want to own:
- diversified across the world
- Real Estate (indexes) would allow me to be invested in a less-correlated sector without headaches on tennants and crappy house problems
- diversified across all market caps
At first glance I was thinking about these indexes:
- US: S&P 500
- World stock market fund
- Real estate – via REITs
But maybe my research will lead to better choices? I believe in Keep It Simple but a simple concept as an index tracker is darn complex. Search on justETF.com and you find 1310 ETF’s (Index Trackers). Hold on, this ETF selection is even depending on the country of residence? If I select ‘Belgium”, I get another selection than if I select “France”? Even if you select for “Europe – large cap” to find Euro stoxx 50 (just as an example) and you will find 24 ETFs which represent the index. Each one has different conditions, different exenses, size,… What a jungle!
Just the facts, please: what to expect
The last 30 years (1988-2018), the S&P 500 US large-cap stock market index had these returns (DIY with this calculator; I apply the last 30 years, for longer periods the results are very similar)
|Dividend Gross||2.8 %|
|Capital Gains||5.9 %|
|Total Return||8.7 %|
- a total return of 8.7 % annually. In the fantasy-world of gross returns on the dividends, zero taxes, and zero expenses. Which means that your real-world returns will be lower; as an important note, dividends are 2,8 % of that 8.7 % return,
The world of zero taxes and zero expenses
Note that in Europe, stock markets have a very comparable track record: The STOXX 50 EUR index also has 7% capital gains and 3.3% dividend return (1987 – 2018).
FIRE investors know how important it is to keep these low, especially because you want to keep your fund very very long. Expenses are:
- broker fees (when purchasing and selling shares). Sometimes certain ETFs are available for zero transaction charge via your broker. It depends on the combination account – broker – exchange – specific index fund.
- fund entry / exit expenses. Some funds ask an additional fee when purchasing the indexfund; these are called “front-end fees”, when selling your fund it’s called “back-end fees”; They could be huge, up to 5% and more. You have lost your money before you even started if a fund takes 5% as a front-end fee.
- Additionally, most brokerages require you to hold an ETF for a certain number of days, or they charge you a fee. ETFs aren’t normally intended for day-trading.
- Even worse, some brokers and banks charge you just to hold an account with them. It seems to be more frequently the case in the UK. It is kind of scandalous, you put your money on their accounts, they receive trading fees, and on top they charge a fee because you do business with them?
- Sometimes you are charged a fee if your average balance is too low, eg there is a threshold of 10.000 USD for some Vanguard accounts. Note: Vanguard apparently changed this threshold very recently (November 2018) to 3000 USD.
Lots of “sometimes” and “could” in the above section. Buyer be aware; Check it out for your particular case; Do your homework or you are eaten alive by broker and fund.
Annual management expenses = TER (Total Expense Ratio)
I know you know the importance, just to illustrate this (assume zero taxes and perfect index tracker):
- Age 25 save till 65: save 300 EUR / month in SP500 at 0.04% annual expense –> 1.762.707 EUR @ age 65
- Age 25 save till 65: save 300 EUR / month in SP500 at 1.24% annual expense –> 1.273.054 EUR @ age 65
That’s some 500.000 EUR difference between a low expense index fund and a higher-ish expense fund. You get nothing in return for the more expensive fund. It tracks an index just as all the other funds.
Note: these are real-life examples. 0.04 % is what a SP500 Vanguard Admiral fund takes, 1.24 % is what my local Belgian Pensionfund (Fortis) charges.
Underperformance is more than just expenses
The real performance of your index fund depends on more than just the expense ratio. The total lagging on the index is called “tracking error”
- Tracking Error / Difference: a real fund cannot perfectly mirror the index. It has to purchase and sell stocks and keeps a bit of cash. The (annual) difference between a fund’s return and its index’s return is the tracking error. Expense ratio, rebalancing costs, cash drag, and dividend tax can all contribute to tracking difference.
- Fund Turnover: how frequently assets within afund are bought and sold. Higher turnover leads to higher transaction cost.Fund turnover costs are not included in the expense ratio.
- Rebalancing: how often a fund changes its holdings to maintain asset allocations.
- Tax Cost Ratio: The reduction in a fund’s annualized tax return because of taxes on distributions.
- Cash Drag: an ‘index fund’ does not freakingly buy and sell all index stocks for each share of the fund bought or sould, it tries to find a balance between avoiding transactions while still tracking the index. This inavoidedly causes a bit of drag on the index.
The point to take away is this: an index tracker has a TER but also a tracking error. You will notice small differences between funds tracking the same index. After five years, one fund may show a cumulative return of 92.5 % and another one 90.9 %, while both have the same expense ratio of 0.15 % and track exactly the same stock market index. The difference is due to these additional factors. The 92.5 % fund is managed just a bit more efficiently because of turnover, rebalancing, cash buffer, more intelligent tax handling etc. See here for more background
In some cases, the number is really huge: some ‘index tracking’ funds offer a low expense ratio but still differ 1.25% annually (in the negative direction) from the index. In other words, the index maybe went up at 9% average over the last 10 years, and your ‘index fund’ went up 7.75% due to ‘a small tracking difference’. In such a case, what good is it to zoom in on a 0.05 % expense ratio if you lose more than 1% due to fund inefficiencies?
What expense ratio to aim for?
Most Index funds are relatively inexpensive. Some carry expense ratios as low as 0.03%. One of the largest index trackers, SPY or S&P 500 SPRD has an expense ratio of 0.0945%.
US: Vanguard –> Europe: ?
Vanguard is a financial company offering investment accounts and financial products such as index tracking funds and ETF’s. Problem is that they are usually available directly through Vanguard or through a Vanguard-managed relationship with your USA employer.
If you have read 20 blogs on FIRE and you have been completely brainwashed to look only for very low-expense ‘Vanguard’ index funds, you may have a hard time here in Europe. Vanguard does not accept international customers at their own broker. There are a few options if you really INSIST on a Vanguard account in Europe, and there is a topic on ‘international Customers’ on their website, but it’s all very difficult and kind of a cumbersome workaround.
Instead of trying to open a Vanguard account, you can simply open an account with any local stock broker and buy ETFs just like you would any international share. So forget about the Vanguard accounts and choose amongst any low-expense index ETF, regardless if it is a Vanguard index fund or any other brand.
More bad news: “smart” European regulators have ‘protected‘ their citizens against “extremely risky” investing methods such as Vanguard ETFs. Apparently this “protection” is due to a new European regulation (MIFID II whatever) which requires a fund or tracker to have information available in the local language. It is simply impossible to purchase a number of funds as a European resident. I have a UK and a dutch (NL) broker, and both refuse to let me purchase very popular Vanguard trackers. No VTSAX, VXUS, VTI or VT for me! Also no SCHH or SWTX (Schwab) and a series of iShares. I can choose between European equivalent index trackers, but these local ETF’s are smaller and more expensive (higher TER).
What I can do however is purchase bitcoins. THAT is completely safe according to Europe. Go figure.