My client asked me this question: The expense ratio of ETF A is around 0.5% vs ETF B which is 0.25%. Why did you recommend the former instead?
Answer:
First, the index which both ETFs track is not the same. ETF A tracks the MSCI World whereas ETF B tracks the FTSE All World. So the comparison is not apple-to-apple in the first place.
Second, expense ratios do not tell the entire story.
The alpha for ETF B is -0.62% compared with ETF A’s -0.56% over a 3 years period. As it can be seen that the ETF B is worst off. Despite it only have 0.25% in expense ratio, it has more than 0.25% in tracking error.
| Alpha | Beta | |
|---|---|---|
| ETF A | -0.56 | 0.99 |
| MSCI World | 0 | 1 |
| Alpha | Beta | |
|---|---|---|
| ETF B | -0.62 | 1 |
| FTSE All World | 0 | 1 |
Other consideration when purchasing ETFs are:
- Liquidity. The higher the liquidity the better.
- Reputation of the ETF provider.
- Tax impact. Recently I met another person who invested more than US$500,000 of stocks listed in the US because he follows some website. When I told him he is being taxed 30% of all dividends received, he almost fell off the chair. When I told him of the hefty estate duty, he got another heart attack. To cut the long story short, he decided not to engage me for financial planning. I guess he still prefer to follow some website blindly instead of paying a fee for professional advice.
- Regulation.
- And whether is the ETF ‘synthetic’ or ‘physical’.
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Many Sinkies getting around the estate duty by having another family member know their online trading account ID & password. Same thing for easy access to bank accounts too with internet banking credentials being made known to other family members. Illegal to evade the tax but what the hell — no way for govts around the world to enforce. Maybe US will send in SEAL Team 6 after you at 4am in the morning.
As for the 30% withholding tax on dividends for non-US residents, 1 way to get around is to file for US IRS W8BEN form to reduce the tax to 15%, but it’s cumbersome (and not sure whether still applies to non-treaty countries like S’pore).
Another way is to sell the stocks just before ex-dividend date and buy just after, but many things to consider — trading expenses, forex movements, forex fees, liquidity issues (you don’t immediately get cash from selling your cum-dividend stocks today and then buy the ex-dividend stocks tomorrow).
BTW, as non-resident foreigners, you don’t need to pay capital gains taxes for US stocks.
If you’re talking about individual stocks, then I guarantee the above will be too much headache unless you full-time investor with 8-9 hours a day doing all these admin & trading stuff.
If you’re investing in ETFs or index funds, then go for those “tax-friendly” ones that don’t pay out dividends.
Of course the final option will be the one most recommended by financial advisors — “offshore trust accounts” or wrap accounts in a tax-haven country with tax treaties with US. But you need to calculate whether the wrap fees is worth it or not.