If you’ve read last week’s article on investing in shares, but feel a single stock approach is too risky or requires too much research for you, then an ideal way to get started is to spread your risk by investing in a fund.
A fund is a pooled investment where your money is put together with cash from many other investors and invested in a host of assets. A fund can track a stock exchange index, or invest in a range of stocks, bonds or commodities, allowing you to access a broad range of global assets at a low cost, and at less risk than putting your money into individual stocks.
But how do you buy them? How much will they cost, and what tax will you pay on them?
How can I invest?
Irish-based investors have a couple of options when looking to put money into a fund as they can be structured as a life-wrapped fund, a UCITS (Undertaking for Collective Investment in Transferable Securities) or an ETF (an exchange-traded fund).
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“The actual investment fund is pretty much the same,” says Dara O’Brien, head of retail client relations at Irish Life Investment Managers, adding that the only difference between the three is the wrapper put on the first type of investment by life companies.
Life-wrapped funds are life insurance products sold by providers like Irish Life, Zurich Life and Standard Life. You typically invest in one via a third party like your bank or financial adviser.
You can either invest a lump sum in such funds or on a regular basis, typically from €100 a month.
One attraction for the novice investor is that they are simpler to sort in terms of taxation, as the life company looks after the tax. There can also be benefits in the event of passing on the product without encashing it in the event of the owner’s death.
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The second option is to open an account with a stockbroker as we outlined last week and buy a UCITS fund via a platform like Degiro or Davy Select, which has 1,400 funds and 1,000 ETFs available. Typically, your choice will be broader here. UCITS refers to open-ended investment funds that comply with European Commission regulations for investments sold across borders.
The third option is an exchange traded fund (ETF). This is a pooled investment fund that is traded like a stock, hence “exchange traded”, and is thus priced throughout the day – compared to an investment fund which is priced when the market closes.
One other option is a UK investment trust. This is similar to a fund in that it pools money to invest in certain assets, but is traded on a stock exchange.
How much will it cost?
Charges will differ depending on the structure, and type of investment.
In terms of investment strategies, both active and passive strategies exist within all of the three options. A passive strategy aims simply to mimic the performance of an index while an active strategy aims to outperform a benchmark index or basket of products.
Typically, for example, you will pay more for an actively managed fund. Its sponsors will argue the expertise of its fund managers give you a chance of better, or less volatile, returns.
A passive fund aims to track the performance of a specific index, such as the S&P 500 or FTSE 100. As it doesn’t plot its own investment strategy, such funds tend to be cheaper.
Life wrapped funds are also more expensive. Consider as an example New Ireland’s Technology Indexed Fund, which invests in the State Street SPDR S&P US Technology Select Sector UCITS ETF.
Actually, before we look at the costs, let’s parse what that fund name means as these can be confusing in themselves.
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State Street is the finance house that has put the product together. An SPDR is a Standard & Poor’s Depositary Receipt, which is a form of ETF. UCITS and EF we’ve explained above but the S&P Technology Select Sector UCTS ETF tracks something called the S&P Technology Select Sector Daily Capped 35/20 index.
This index tracks the top companies in the technology and telecoms space. But what about that 35/20? That means the largest single component in the index cannot account for any more than 35 per cent of the index regardless of the company’s actual size. Similarly, the 20 means no other constituent can account for more than 20 per cent. And Daily Capped means it is monitored for those caps on a daily basis.
As you can see, it can take a bit of work to find out what you are investing in. Anyway, back to the charges.
With New Ireland, you will have an annual management fee, plus transaction costs, of about 1.9 per cent for this fund. If you just bought the ETF on the other hand, your annual management fee will be just 0.15 per cent (although you will have trading costs).
“Normally what makes life policies more expensive is that generally you’re buying them through a financial adviser so you’re paying for this add on advice fee,” says O’Brien.
And, life wrapped funds also come with an insurance levy of 1 per cent on all contributions. This doesn’t apply to ETFs/investment funds.
“Again, that’s a barrier to investing,” says O’Brien, noting that the hope is that the new Government savings scheme might allow for a different type of wrapper, which isn’t liable to this levy.
However, despite the higher charges, Brian Weber, head of investments with Omnium, says such funds can make perfect sense for those investing smaller amounts.
“No tax returns are involved, so it saves you a lot of headaches,” he says.
Watch out for early encashment charges, which can be applied up to the first five years.
If advice is part of your fund strategy, bear in mind there will be additional costs for this, either as a percentage of your investment, a fixed fee or commission.
If you buy the fund through a broker, for example, there may be a commission charge, such as an allocation rate. This can mean that 100 per cent of your money is invested in the fund and the adviser gets commission of up to 5 per cent but it is you who ends up paying for this in higher charges over the life of the fund.
“It’s really important to ask the questions,” says O’Brien, and to get it spelt out just how much the advice is costing you, and if this is something you’re comfortable with.
“They should be disclosing the full list of fees and charges, and the impact it might have on growth of the investment,” says O’Brien.
How risky is it?
Most life companies offer risk profilers that help you ascertain where you sit on the risk spectrum- for example Standard Life’s is here. Once you know where you sit, you can bear this in mind when looking for an investment fund, as fund managers will typically assign a rating, indicating the risk profile of the fund.
For example, the iShares Developed World Index has a risk rating of “5″ with Zurich, indicating that it is of “medium to high risk”.
Multi-asset managed funds can be a lower risk alternative. Irish Life’s MAPS (multi-asset portfolio funds) range for example, has a risk rating from 2 at the lower risk end to 6.
As with stocks, a diversified approach to funds can help lower risks. In addition, dollar cost averaging, whereby you put money into a fund each month rather than as a lump sum, can help smooth any peaks and troughs, and can reduce your risk.
And remember always, that just because a fund does well one year, there is no guarantee that this performance will be repeated. Look at the underlying assets and the factors affecting them.
What about taxes?
It’s a frequent bugbear of many funds investors in Ireland. Gains on funds are subject to so-called exit tax at a rate of 38 per cent (it was 41 per cent until last year’s budget), which is some way higher than capital gains tax (CGT) at 33 per cent. Moreover, where you can offset capital losses against gains on the sale of other assets, no loss relief applies with exit tax.
And “deemed disposal” means this “exit tax” is levied on the profit in your fund every eight years regardless of whether you actually sell out of your investment.
While change may be on the way as part of the Government’s plans to review the sector, for now it remains quite complicated, given a fund’s domicile can impact the tax regime that applies.
If you want to keep it simple, the best option is probably to opt for a life wrapped fund, mentioned above. These are subject to life assurance exit tax, levied at the same rate as exit tax at 38 per cent. The advantage, however, is that the life assurance company will manage that tax at source. It will also pay any tax owed to Revenue as part of deemed disposal.
“What does cause difficulty is the eight-year deemed disposal rule,” says Catriona Coady, Goodbody Stockbrokers.
The downside however, is that the life company will pay over tax owed from the fund itself, which might impact growth.
For reasons such as this, as well as costs, some investors opt to buy investment funds or exchange-traded funds – although traded like a share, they are treated for tax purposes like a fund – through a broker.
You will also pay exit tax at 38 per cent on gains in these products, and they are also subject to deemed disposal but you can use money you held in cash to pay this bill, and leave the investment intact.
If investing in a fund this way, the onus is on you to account, report and pay any tax owed. It can be particularly complicated if you invest on a monthly basis to work out what tax you owe after eight years, which is a big downside.
“Similar to your share history for direct equities, a record should be retained around dates of acquisition and prices,” says Catriona Coady, of Goodbody Stockbrokers.
If your fund pays an income, this will be subject to exit tax at 38 per cent. No USC or PRSI apply, which is more favourable to dividend income from a share.
It gets a bit more complicated however, when it comes to offshore funds. Depending on where the fund is domiciled, it might either be liable to capital gains tax or exit tax.
For example, according to Goodbody, funds in regulated jurisdictions – such as those in the EU, the European Economic Area (which adds Iceland, Liechtenstein and Norway to the EU basket) or OECD countries – will be liable to exit tax and deemed disposal.
If, however, the fund is not a limited partnership, or unit trust or UCITS or equivalent, but is domiciled in one of those countries, then income tax, PRSI and USC will be liable to any income, and CGT to any gains.
And it doesn’t end there. Offshore unregulated funds, located in places outside the above countries, such as in Jersey, are treated differently again. They are liable to income tax plus PRSI plus USC on income, plus a 40 per cent capital gains tax charge.
“Simplification is definitely warranted,” says Coady.
It’s worth noting that investment trusts are subject to the CGT regime, and thus deemed disposal doesn’t apply.
How can I exit my fund?
“It might be a misnomer out there, but it’s perfectly possible to invest through any of those kind of wrappers (funds) and have instant access to your money,” says O’Brien.
With an ETF, you sell it as you would a share. What might impact on you cashing in however, is volatility in the fund. If the investment is down, for example, you may not want to cash it in.
PANEL: Forget 38+8 – here’s a way to avoid exit tax regime
Looking for a product that is “tax efficient, tax aware and will protect you on the downside”? Brian Weber, head of investments with Omnium, an investment platform which supports brokers and financial advisers, says he has the answer.
He has identified a gap in the marketplace for those investors sick of “38+8” – the 38 per cent deemed disposal regime outlined above – by putting together a portfolio structured around assets that are subject to capital gains tax (CGT) and which protects against the possibility of future US estate (inheritance) tax.
He is building the structure “as if I’d invest in it myself”.
First up is to buy Irish domiciled assets, rather than US securities, due to the potential of being landed with a federal estate tax bill upon death.
“It can be absolutely swingeing,” he says. The potential issues hit home when the wife of a deceased client of Weber’s, who had over €4 million in US assets, was hit with a federal estate tax bill of €1.8 million. There was no CAT liability, due to tax free transfers between husband and wife in Ireland, and thus no spousal offset in the US.
But rather than an exchange traded fund (ETF) – which is subject to exit tax at 38 per cent plus deemed disposal after eight years – Weber is using exchange-traded notes (ETNs).
A debt instrument, these are subject to the CGT regime, and are traded on the stock exchange. The return is linked to the performance of an underlying index, and they bring issuer credit risk, in the event that the issuer can’t meet its obligations. Barclays Bank iPath ETN range for example, tracks commodity, energy and S&P 500 indices.
When there is an income with such funds, Weber says accumulating funds “are much better for Irish clients” from a tax perspective,
Backing these up will be UK investment trusts, which are also subject to the CGT regime.
“The idea then is to protect people’s capital on the downside,” he says, pointing to trusts like the Personal Assets trust, which focuses on protecting and growing investors’ money.
Irish government bonds will also feature. “They are trading well below par [their face value], and the gain to par is tax free,” he says.
‘How to Invest’ is a series of articles guiding readers through the basics of investing in different assets. See also: The risks of leaving money on deposit and How to invest in shares. Next week: Bonds
