Beginning in Investment - A Better Strategy for the Long-Term

Hi,

Note: This strategy will work best if you have €10,000 minimum to start with and can add €300+ per month to the portfolio.

Taking into consideration my thread here ETF's, Direct Shareholdings and the new 8-Year Rule and considering that ETF's will probably fall under the new 8-year rule, would the following be considered a sensible investment strategy.

When looking to diversify, the general consensus is that 10 should be a minimum but, for this strategy, I think 20 is a better number. Therefore, if you look at the Eurostoxx 50, select the top 20 companies and purchase shares in each share in the same proportion as they are (relative to each other) in the index, you will have exposure to 61.72% of the index.

For example, the chart below highlights the top 20 shares currently in the Eurostoxx 50. If you look at the first - TOTAL - the first number represents the percentage of the full Eurostoxx 50 made up by that company - 5.65%. The second number highlights what percentage of the top 20 companies is made up by that company in the index - 9.154245%. The third number highlights how much out of €20,000 you should invest in that company to gain the correct exposure.

1 TOTAL........................................5.65...9.154245...1830.85
2 SIEMENS.....................................3.78...6.124433...1224.89
3 BCO SANTANDER CENTRAL HISPANO.3.69...5.978613...1195.72
4 E.ON..........................................3.62...5.865198...1173.04
5 NOKIA........................................3.47...5.622165...1124.43
6 ALLIANZ.....................................3.33...5.395334...1079.07
7 BNP PARIBAS...............................3.31...5.362929...1072.59
8 TELEFONICA................................3.06...4.957874...991.57
9 UNICREDITO ITALIANO...................2.99...4.844459...968.89
10 ING GROEP.................................2.96...4.795852...959.17
11 ABN AMRO.................................2.82...4.569021...913.80
12 ENI...........................................2.79...4.520415...904.08
13 BCO BILBAO VIZCAYA ARGENTARIA.2.77...4.48801....897.60
14 DAIMLERCHRYSLER......................2.76...4.471808...894.36
15 GROUPE SOCIETE GENERALE..........2.75...4.455606...891.12
16 SANOFI-AVENTIS........................2.72...4.406999...881.40
17 AXA..........................................2.47...4.001944...800.39
18 DEUTSCHE BANK R.......................2.41...3.904731...780.95
19 INTESA SANPAOLO S.P.A..............2.28...3.694102...738.82
20 SUEZ........................................2.09...3.386261...677.25
..................................................61.72...100.00.....20000.00

Now, of course, you will have to take charges into account. With Interactive Brokers, there is a minimum total charge of $10 per month and a minimum charge of €4 per transaction for European share purchases. As $10 is €7.32 at todays exchange rate, we can assume that we can make 2 transactions per month at a total cost of €8 per month.

This is a buy and hold strategy and so we never want to sell any of our shares if we must pay tax on the gains. Therefore, we must select 2 of the top 20 of our holdings each month to buy and apportion our investment for that month between those 2 choices with one exception - if one of the shares drops from the top 20, we can sell enough of them to use up our annual capital gains tax allowance for that year and any subsequent years and use the proceeds (along with that month's investment) to purchase the new top 20 share - we will never sell anything that arizes a tax liability.

Let's assume we're investing €1,000 at the end of each month. We select the 2 companies most out of sync with the current percentages made up by the index. To divide the money, for example, lets say UNICREDITO ITALIANO is supposed to currently make up 3.5% of the index and E.ON is supposed to make up 5% of the index but our holdings in each is currently valued at €2,900 and €4,000 respectively. Our total holdings of these 2 companies are going to be €7,900 after the purchase. This means that, based on the above percentages the following should be our holdings in each:

UNICREDITO ITALIANO - €7,900 / 8.5 * 3.5 = €3,253
E.ON ------------------ €7,900 / 8.5 * 5 = €4,647

Therefore, we'd purchase €353 of UNICREDITO ITALIANO and €647 of E.ON.

The above would suit the people of a passive nature as there's only a little mathematics at the end of each month and no investigating company books, etc. It will not track the Eurostoxx 50 as thats not the purpose of the strategy, but it will provide diversification and will avoid the temptation to sell shares for the wrong reasons. For example, many people tend to sell a share if it drops alot in a particular period of time. However, they always tend to bounce back (which is why index investors who continue to buy the shares after they drop tend to do well).

When compared to, for example, investing in Quinn Direct funds which have an annual management charge of 1%, the following are the charges that apply (if investing an initial €20,000 and €1,000 per month).

Quinn

Initial Charge - €0
Year 1 Annual Charge - Probably above €260 assuming any growth
Year 2 Annual Charge - Probably above €320 assuming any growth
Year 3 Annual Charge - Probably above €380 assuming any growth
Year 4 Annual Charge - Probably above €440 assuming any growth
Year 5 Annual Charge - Probably above €500 assuming any growth
Every year after - Rises more

Above Strategy

Initial Charge - €80 (20 purchases at €4 each)
Year 1 Annual Charge - €88 (11 months at €8 per month)
Every year after - €96 (12 months at €8 per month)


However, the above is not a like for like comparison as if you are willing to open an account with Interactive Brokers to follow the above strategy, you will probably purchase ETF's directly rather than invest in Quinn Direct. To see the difference in buying shares directly (possibly using the above strategy) and ETF's, see ETF's, Direct Shareholdings and the new 8-Year Rule

Hi Ronald

I see where you are coming from, but it's a huge amount of work for very little savings. Owning shares directly in European companies is awkward. I had them a few years ago and I had no idea what was happening. When dividends went missing, I spent ages chasing them up. Then more time trying to find out about tax deductions.

There will be rights issues, scrip issues, share splits and mergers. Each one is time consuming.

It really is not worth the hassle.

And if you factor in your time at €50 an hour, then it's far more expensive than buying an ETF or tracker.

Where are you getting 20 shares from?

If it was your entire wealth, then 10 is enough.

If it's only a part of your wealth, then 5 is plenty.

Brendan

The reason I chose 20 was because the strategy outlined above doesn't buy shares in equal amounts, i.e. if I was spending €10,000 on the top 10 shares, I wouldn't be buying €1,000 in each but would instead have it split based on the proportion of the Eurostoxx 50 each share occupies. I wouldn't feel comfortable having almost 16% of my wealth tied up in one company based on the percentages of the top 10 companies in the table below. Also, buying 10 would only give me exposure to 36% of the index as opposed to 62%.

1 TOTAL........................................5.65...15.76%
2 SIEMENS.....................................3.78...10.54%
3 BCO SANTANDER CENTRAL HISPANO.3.69...10.29%
4 E.ON..........................................3.62 ..10.09%
5 NOKIA........................................3.47. ..9.68%
6 ALLIANZ.....................................3.33.. .9.29%
7 BNP PARIBAS...............................3.31....9.23%
8 TELEFONICA................................3.06....8.53%
9 UNICREDITO ITALIANO...................2.99...8.34%
10 ING GROEP.................................2.96...8.25%

Anyway, using the strategy I've highlighted above, the only additional costs in owning 20 shares as opposed to 10 shares is the additional €40 you'd have to pay in commission at the beginning. After this, you're limiting yourself to a maximum of 2 trades per month so as to keep the commissions to a minimum.

After the initial 20 are set up, it's just a matter of the following at the end of each month when you've got your next batch of money to invest:

1. Check that the top 20 Eurostoxx 50 companies are still the same and,
2. If not, sell enough of the company that's dropped from the top 20 to use up your annual CGT allowance and use the proceeds together with this months investment to purchase stocks in the company that's joined the index (that's your 2 trades for the month),
3. If so, work out the percentage of your portfolio held in each company, check the percentages each company makes up in the index at that point in time by looking at http://www.stoxx.com/indices/components.html?symbol=SX5E and choose the 2 companies where your current holdings are most out of sync. Then work out how much of your investment to put in each company using the method shown in my previous post (that's your 2 trades for the month).

Rule: Never sell shares when doing so would cause a tax liability. Therefore, you'll only sell shares when they have dropped from the top 20 and you have a CGT free allowance to use for the year. This means, when a share drops from the top 20, you'll sell enough to realise a tax-free profit of €1,270 and keep the rest. Your portfolio will then consist of 21 shares and you can keep the 21st until it rejoins the top 20 in which case you'll buy back some more or, another tax year passes and you can sell another batch to realise a tax free profit of €1,270.


All in all, I'd say the above will take about 1 hour (2 at most) per month. It might not be such a good idea for someone who wants a truly passive investment vehicle but I think it does have it's merits and does deserve at least some consideration.

I've just been reading up on "Bed and Breakfasting" - a practice whereby people used to sell shares to realise a there CGT tax free profit of €1,270 and then immedietely buy them back. The government has introduced a 30-day rule whereby if you buy them back within 30-days, you cannot use the CGT tax free allowance.

Therefore, when using the above strategy, if the 20th company dropped out of the index one month and you had 1500 shares purchased at €3 each but now worth €5 each. You would sell enough to make a profit of €1,270, i.e. 635 shares and keep the other 865 shares thus using up your annual CGT free allowance.

If, in the next month, that company re-entered the top 20, you would need to wait until the 31st day (which is pretty much what you're doing in the above strategy anyway) and then repurchase enough shares so that you have the correct number of shares in that company. Remember - We DON'T want to ever have to pay tax ;-)

Of course, you wouldn't be able to sell any of the company that was briefly in the top 20 until the next tax year without paying tax on profits. Therefore, we can either keep them if they have rose in value or make our own choice about whether to keep them or sell them if they have dropped in value - I would usually lean towards keeping them because we don't want to sell at a loss and, anyway, chances are they will rise again and possibly re-enter the top 20 next month.

Brendan said:

Hi Ronald

I see where you are coming from, but it's a huge amount of work for very little savings. Owning shares directly in European companies is awkward. I had them a few years ago and I had no idea what was happening. When dividends went missing, I spent ages chasing them up. Then more time trying to find out about tax deductions.

There will be rights issues, scrip issues, share splits and mergers. Each one is time consuming.

It really is not worth the hassle.

And if you factor in your time at €50 an hour, then it's far more expensive than buying an ETF or tracker.

Where are you getting 20 shares from?

If it was your entire wealth, then 10 is enough.

If it's only a part of your wealth, then 5 is plenty.

Brendan

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what is the tax staus on european dividends? I know its a complicated question but does anyone have a brief summary? is it a case of getting taxed in Spain and having to pay here or is tax deducted at source at all in Europe?

ronaldo said:

Now, of course, you will have to take charges into account. With Interactive Brokers, there is a minimum total charge of $10 per month and a minimum charge of €4 per transaction for European share purchases. As $10 is €7.32 at todays exchange rate, we can assume that we can make 2 transactions per month at a total cost of €8 per month.

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What about stamp duty (or equivalent) on share purchases - e.g. 1% in Ireland, 0.5% in UK etc.?

You'd have to make sure that, in the unlikely event of an Irish or UK share entering the top 20 that you eliminate it and go for the top 21. Ireland and the UK are the only countries where stamp duty is payable.

My comment on above strategy is that is could be considered to be overweight in financial companies - banks and insurance companies make up 50% of total investment.

Another strategy would be to avoid duplication of companies within each industry segment and to ignore weighting on a market capital basis. The aim is to attain a degree of diversification across industry sectors not just follow the index.

Well it would have to be automatic, i.e. no personal selections of comapanies as this is where trading would start. How about if you only allowed two companies in the same sector. This would make it look like the following for a €20,000 investment which gives you a 55% exposure to the index:

Name...........Sector................Index %...Our %..... Amount
TOTAL..........Oil/Gas...............5.65........10.25........2050.82
Siemens.......Industrials............3.78.........6.86........1372.05
BCOSAN......Banks.................3.69.........6.70.........1339.38
E.ON...........Utilities................3.62.........6.57.........1313.97
Nokia...........Technology..........3.47.........6.30.........1259.53
Allianz..........Insurance............3.33.........6.04.........1208.71
BNPParabis.Banks..................3.31.........6.01.........1201.45
Telfonica.......Telecom..............3.06.........5.55.........1110.71
INGGroup....Insurance..............2.96.........5.37.........1074.41
ENI .............Oil/Gas................2.79.........5.06.........1012.70
Daimler........Automotive...........2.76.........5.01.........1001.81
Sanofi….......Healthcare...........2.72.........4.94..........987.30
SUEZ...........Utilities................2.09........3.79..........758.62
BASF...........Chemicals...........2.01........3.65..........729.58
Bayer...........Chemicals............1.83........3.32.........664.25
DeutsheT….Telecom.................1.77........3.21.........642.47
Unilever........Food/Beverages....1.71........3.10..........620.69
Vivendi.........Media..................1.57.....2.85.............569.87
Philips..........LeisureGoods......1.52.....2.76.............551.72
SAP ............Technology..........1.46....2.65.............529.95 .
.............................................55.10....100.00.........20000.00

ronaldo said:

if one of the shares drops from the top 20, we can sell enough of them to use up our annual capital gains tax allowance for that year and any subsequent years

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What exactly do you mean by the bit in red? You cannot use future years' annual CGT allowance in advance or carry forward unused annual CGT allowances from previous years if that's what you mean...

Also - I suspect that when it does come to selling and taking money out the CGT issues are going to be far too complicated for most people to deal with by themselves so the costs of getting professional advice must be factored in. CGT complexities alone is one of the main reasons that I personally tend to avoid direct shareholdings as much as possible.

I'd be happy with that selection strategy but would tend to agree with Clubman that dealing with CGT issues would be a problem for most people.

one thing strikes me in this is that in buying the top 20 and selling when a company falls out of top 20, you are effectively saying buy high and sell low. Holding for long term is great but better if you manage to buy one of the greats when they are at a temporary low, difficult to do I know.

ClubMan said:

What exactly do you mean by the bit in red? You cannot use future years' annual CGT allowance in advance or carry forward unused annual CGT allowances from previous years if that's what you mean...

Also - I suspect that when it does come to selling and taking money out the CGT issues are going to be far too complicated for most people to deal with by themselves so the costs of getting professional advice must be factored in. CGT complexities alone is one of the main reasons that I personally tend to avoid direct shareholdings as much as possible.

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Sorry, I was a bit vague there. What I meant is sell enough of the units to realise your capital gains tax allowance and keep the rest until the next tax year and then sell some more to use up that tax years allowance, unless of course the share re-enters the top 20.

I totally agree with the idea of CGT issues being too complicated for alot of people but the strategy may be a good one for those who understand FIFO principals and how to file tax returns. It also may be beneficial to alot of the posters who post from time-to-time that have large amounts to invest for the long-term.

For example, let's consider the extreme. Say someone inherets €400,000 and are retired. Finances to this person is like golf to other retirees and they actually enjoy watching and playing in the markets. They don't need the money as their pension is adequate for them but they want to invest the money for as long as they live for their own childrens inheritences. Assume dividends are 2.5% per annum, growth is 9% p/a and they are a lower rate taxpayers.

By using the above strategy and reinvesting the dividends, their fund will be worth €2,996,358 after tax is paid (and this assumes you never use the annual CGT allowance which you obviously will using the above strategy and so the actual figure will be higher).

By using the ETF strategy, using the new 8-year deemed disposal rule and assuming that afer the twentieth year all shares are sold and the CGT for the final 8 years is paid, the figure works out at €2,492,632.

So, say we spend 2 hrs per month for 20 years, thats 480 hours. The difference in fund values is €503,727. That's a salary of €1,050 per hour after tax.

pernickety said:

one thing strikes me in this is that in buying the top 20 and selling when a company falls out of top 20, you are effectively saying buy high and sell low. Holding for long term is great but better if you manage to buy one of the greats when they are at a temporary low, difficult to do I know.

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Whilst I agree this is true. The fact of the matter is that any index tracker works on this principal and this strategy is aimed at being relatively passive by mimicking the index trackers to a certain extent. The purpose is to avoid the losses incurred by the new 8-year rule.

There will be charges associated with the stockbroking of €96 per year. These charges are also incurred with ETF's but you avoid the 0.25% AMC with ETF's and you avoid the 8-year rule. With Quinn Funds, the charge is 1% AMC which means that once your holdings reach €9,600, the direct holdings/ETF's work out cheaper.

ronaldo said:

but the strategy may be a good one for those who understand FIFO principals and how to file tax returns.

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I understand both but still find it enough hassle to avoid where possible. Trawling through the eircom figures to calculate losses in order to set them against First Active capital repayment gains was enough to put me off this stuff for the forseeable future (even if I still have losses to use against gains).

Finances to this person is like golf to other retirees and they actually enjoy watching and playing in the markets.

Click to expand...

I would say that this would be a minority of the general population to be honest.

We're almost at the height of the bull market now and if we start investing now, we'll ride down, averaging down for lesser value. It's best to wait until the next market cycle to get in (i.e. end of bear market). Remember the Dot Bomb? I know the top 20 weren't as badly affected but still when the whole market is going down, the rest will follow, now matter how strong it is. Have to do more due diligence than buying the top 20.

howdydoo said:

We're almost at the height of the bull market now and if we start investing now, we'll ride down, averaging down for lesser value. It's best to wait until the next market cycle to get in (i.e. end of bear market). Remember the Dot Bomb? I know the top 20 weren't as badly affected but still when the whole market is going down, the rest will follow, now matter how strong it is. Have to do more due diligence than buying the top 20.

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Can you predict the future?

howdydoo said:

We're almost at the height of the bull market now and if we start investing now, we'll ride down, averaging down for lesser value. It's best to wait until the next market cycle to get in (i.e. end of bear market). Remember the Dot Bomb? I know the top 20 weren't as badly affected but still when the whole market is going down, the rest will follow, now matter how strong it is. Have to do more due diligence than buying the top 20.

Click to expand...

Are you for real? How do you know when the next market cycle will begin?

ShaneMc said:

Are you for real? How do you know when the next market cycle will begin?

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Easy.. See http://en.wikipedia.org/wiki/Mystic_Meg for details..

I never said I could predict the future. Predictions for fools and liars. I apologize if I wasn't clear enough. I'm just saying using a little fundamental and technical analysis you can get a more accurate picture of where we are in the market cycle.

The bull market has been well underway since 2003. I'm just saying it might a little late to get fully invested. I'm trying insert a chart and can't seem to make it appear. Here's the link though. Ideal buy areas are already gone. Either wait for a correction if you must to get in. But preferably wait for the market cycle for a long term investment.

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