ETFs versus Investment Trusts: The Maths. Maybe ETFs aren't so bad?
There are a lot of posts that say "don't go near ETFs because of the tax". It's easy to see this perspective when you look at the headline tax rates, but I wanted to dig a little deeper and quantify how the two options compared when you starting taking into account more factors.
I took a scenario where two 50k investments were made - one in the Vanguard's All World Accumulating ETF VWCE and the other in FCIT, a popular alternative.
I made the following assumptions:
- Investor is in the upper rate of income tax
- FCIT maintains its current dividend yield (1.5%)
- Gross performance of the two products is identical (1.5% dividend + 6.5% capital appreciation for the IT / 8% capital appreciation for the ETF)
- Both maintain their current fees (0.54% vs. 0.22%)
- Costs associated with buying and selling are ignored (this would be higher for Investment Trusts because of stamp duty, FX fees and potentially higher broker commission)
- The investments are held for 30 years, with no changes in the tax regime during this time
Copy and pasting numbers from gsheets into reddit is a pain, so here is the key number - the relative after tax value in each year if the investor was to sell. Specifically it is (Net Value of ETF Investment / Net Value of IT Investment). Where the value is <100%, the IT is winning. Where its >100%, the ETF is winning. If you want to see the workings then check it out here. This link will prompt you to make a copy of the sheet, where you can play around with the numbers yourself.
| Year | Relative Net Return |
|---|---|
| 1 | 99.32% |
| 2 | 99.37% |
| 3 | 99.45% |
| 4 | 99.58% |
| 5 | 99.76% |
| 6 | 99.98% |
| 7 | 100.25% |
| 8 | 100.56% |
| 9 | 99.90% |
| 10 | 99.31% |
| 11 | 98.79% |
| 12 | 98.34% |
| 13 | 97.95% |
| 14 | 97.63% |
| 15 | 97.38% |
| 16 | 97.18% |
| 17 | 96.08% |
| 18 | 95.07% |
| 19 | 94.15% |
| 20 | 93.31% |
| 21 | 92.57% |
| 22 | 91.90% |
| 23 | 91.32% |
| 24 | 90.81% |
| 25 | 89.48% |
| 26 | 88.25% |
| 27 | 87.13% |
| 28 | 86.11% |
| 29 | 85.19% |
| 30 | 84.36% |
Here are some observations:
- For the first couple of years, the IT overperforms slightly because of the €1240 exemption (the higher your investment amount, the less relevant this exemption is, and vice versa)
- After 7 years, the ETF performance overtakes the IT due to lower drag from fees and dividend tax
- This overperformance grows until the DD event in year 8
- Now that the gross amount is lower for the ETF investment, so the outperformance starts to (slowly) decline
- The rate of decline really accelerates after the 2nd DD event
I did also do this with JAM vs. VUAA and the results were pretty much identical. I know someone will say "what about BRK?". ETFs vs conglomerates is a conversation for a different thread.
Am I missing something here? Is there anything I am not considering that would have a material impact on the result? Also the maths of this is a little tricky in a spreadsheet, so have I gotten something wrong along the way?
TLDR; No investor likes deemed disposal, but for investment timelines less than 10-15 years, the positives of ETFs may outweight the negatives.