How Investment Trusts compare to ETFs

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Investment trusts are another investment vehicle which are gaining popularity in Ireland due to their historical returns and preferable tax treatment in Ireland. In this post, I cover how investment trusts compare to ETFs and why I’m still planning on building my portfolio in ETFs (Exchange-traded funds).

What are Investment Trusts

Investment trusts are closed-end funds, typically in the UK and Japan. They are publicly listed companies that invest in financial assets or the shares of other companies on behalf of their investors. You can read more about these here.

Diversification

Investment trusts are a great way to get diversification by buying one “stock”.

Looking at some info on F&C Investment Trust as an example: The first-ever investment trust, launched in 1868. A diversified portfolio gives exposure to most of the world markets. Invests in more than 400 companies in 35 countries. Among the largest investment trusts in its sector.

F&C is invested in a mix of stocks and bonds of companies listed publicly on the stock market, a max of 5% in unlisted securities (not traded on an exchange) and a max of 20% in private equity (direct investments into companies rather than via stock holdings).

Derivatives (investment contracts between the Company and counterparties, the values of which are derived from one or more underlying assets) may be used for income enhancement and efficient portfolio management. Borrowings, which may be short or long-term, in sterling or foreign currencies, would normally fall within a range of 0% to 20% of net assets.

Of the publicly listed companies, it’s invested in companies like: Amazon, Microsoft, Google, Facebook, Apple, Paypal, Mastercard, Visa, Alibaba, Netflix and SAP.

This is actively managed fund and results in higher fees. F&C for example charges 1.18%

Performance

The average annual return for the last 5 years of the F&C has been 14.46%. I believe this is before annual management or purchase fees, inflation and taxes.

The FTSE World Index‘s performance for the same period was 12.8%.

If we take 1.18% fees and 1.9% inflation brings it down to 11.38%. This still does not include stamp duty, currency exchange fees and brokerage purchase costs.

The S&P 500s last 5 years average return was 13.88%. No stamp duty applies. Minus 0.07% fees and 1.9% inflation = 11.91%. If you bought this as an accumulating ETF on Degiro the fees would be 2€/transaction plus 0.03% of the total purchase.

Taxation

The main draw to IT’s in Ireland is the taxation. As you are investing in a company, who in turn invests on your behalf, these are treated as individual stocks and NOT as ETFs.

This means you will be charged 33% tax on capital gains and your marginal income tax rate on dividends instead of 41% exit tax on gains and dividends along with the 8 year deemed disposal rule that comes with ETFs outside of a pension.

Investment trusts are also eligible for 1,270€/year in CGT allowance per person. Not the case for ETFs.

You can also carry forward capital losses from current for previous years to be applied against any future capital gains taxes. Also NOT the case for ETFs.

When you die, if your portfolio exceeds £325k (which a retirement pot typically would be) your beneficiaries may be liable double-taxation on inheritance tax.

Comparison

Assumptions:

Accumulating ETF

Performance: 11.91% after fees and inflation.

Dividend yield: 1.6%

Taxes: 41% exit tax on gains and dividends, exit taxes applied to both gains and dividends from year 8 due to deemed disposal rule. Dividends are automatically reinvested in the fund and no exit taxes applied for the first 8 years due to accumulating ETF.

Purchase costs on Degiro: 2€/transaction + 0.03% of purchase

Investment: 3,000€/month, bought monthly for 20 years (2,997.10€/month after fees)

Value after 20 years: 2.242 Million – Assuming all taxes incurred for like for like comparison.

Investment Trust

Performance: 11.38% after fees and inflation.

Dividend yield: 1.6%

Taxes: 33% on gains, 52% on dividends (assuming higher income tax bracket and all tax credits applied to employment income)

Purchase costs on Degiro: 0.5% stamp duty, 4¢/transaction + 0.05% of purchase + 0.1% currency conversion (Degiro’s AutoFX rate) on purchase and the manual rate of 0.02% on sale.

Investment: 3,000/month, bought monthly for 20 years (2,976.50€/month after fees)

Value after 20 years: 2.248 Million (+0.3% more than the ETF portfolio) – Assuming all taxes incurred for like for like comparison.

Other Considerations

General risk

Personally, I don’t fully understand the risks with investment trusts, in that I don’t understand who actually owns the underlying assets. My understanding is that you are buying a stock in a company and that company is investing on your behalf. So if that investment company goes under, your “stock” in that company at risk.

Based on the KID document for the F&C Investment Trust – this seems to be the case:

“The Company’s shares are listed on the London Stock Exchange. Should the Company be liquidated, the amount you receive for your holding will be based on the value of assets available for distribution after all other liabilities, but before shareholders, have been paid. Shareholders in this company do not have the right to make a claim to the Financial Services Compensation Scheme in the event that the Company is unable to pay out.”

If this is the case, a good investment rule of thumb is to only have 5% of your portfolio in any one company’s stock. As I plan to build a sizeable portfolio which will passively cover my living costs, I do not think that a portfolio made entirely of investment trusts is sustainable if even spread across multiple ITs.

Complexity

If you read through the various fact sheets for ITs, you will see mention of discount rates and NAV (Net Asset Value) performance. From what I can make out, you can buy ITs at a discount to the NAV on some days or more than the NAV on other days. The same applies to when you sell.

So if you buy at more than the NAV and sell at less than the NAV, you will realise less value than if you bought at a discount and sold at a higher value.

I’m not going to pretend I know any more about it than that. I haven’t factored any of this into my analysis as I wouldn’t even know where to begin.

Suffice to say, this adds complexity to both accumulation and withdrawal strategies. Something you may know I like to avoid.

Currency exchange risk

Investment trusts are traded in GBX (British pence) which means you are subjecting yourself to currency exchange risk. But what does this actually mean?

If you look at the historical currency exchange between EUR and GBP here are the highs and low:

  • In the last 12 months: 0.94 and 0.83 = 11% fluctuation
  • In the last 5 years: 0.92 and 0.72 = 16% fluctuation
  • Between 1999 and today: 0.96 and 0.59 = 37% fluctuation

So if the bulk of my portfolio is in GBP which I plan to live off of in retirement (converted to EUR) in say 15 years time, I could have marginally more in growth compared to an ETF portfolio but anywhere from 11%-37% less in value at ay given time due to the difference in currency value.

Even within a given year, if I wanted to withdraw my full years expenses at the beginning of the year to reduce risk, I could lose 11% off the bat to currency difference.

As far as I know, currency exchange “losses” cannot be carried forward as capital gains losses can.

Tax changes

While the tax on investment trusts is currently more favourable to ETF exit tax and deemed disposals every 8 years, as far as I know, Revenue haven’t actually confirmed the taxation of investment trusts and therefore is more likely to change.

If you had built your portfolio around taxation benefits, any changes in this area could drastically devalue your portfolio overnight.

Also exit taxes were once 23% and fund managers are lobbying to have this reduced in line with at least DIRT and CGT. If this should change, ETFs would quickly become an even stronger winner (though I’m not holding my breath).

Final thoughts

As with all of my analysis to date, I keep coming back to the keep it simple approach.

ETFs still tick a lot of boxes for me:

  • easy diversification (hundreds or even thousands of company’s stocks in one ETF)
  • less maintenance (no studying individual company reports, valuations etc)
  • less effort to rebalance (compared to a larger pool of individual stocks/ITs)
  • less currency exchange risk and fees (though still some as underlying assets are in other currencies)
  • low fees to purchase, hold and sell
  • liquid (I can sell off at any time and access at any age, unlike a pension)

I may sound crazy but my goal for financial independence is the freedom of time and peace of mind. If my the cash flow from my passive assets cover my expenses and I have financial security and peace of mind, I don’t really care if my portfolio is worth 1 million or 10 million. Enough is enough for me.

This is why I keep coming back to the simplicity of ETFs.

Detailed calculations

And for those who want to dig into the numbers:

ETF growth

YearFundAnnual SavingsGainExit taxDividendsTaxTotal
1  € 35,965 € 4,283  € 575  € 40,824
2 € 40,824 € 35,965 € 9,146  € 1,229  € 87,164
3 € 87,164 € 35,965 € 14,665  € 1,970  € 139,763
4 € 139,763 € 35,965 € 20,929  € 2,812  € 199,470
5 € 199,470 € 35,965 € 28,040  € 3,767  € 267,242
6 € 267,242 € 35,965 € 36,112  € 4,851  € 344,170
7 € 344,170 € 35,965 € 45,274  € 6,082  € 431,492
8 € 431,492 € 35,965 € 55,674 € 1,414 € 7,479 € 236 € 528,961
9 € 528,961 € 35,965 € 67,283 € 3,750 € 9,039 € 504 € 636,995
10 € 636,995 € 35,965 € 80,150 € 6,012 € 10,767 € 808 € 757,056
11 € 757,056 € 35,965 € 94,449 € 8,581 € 12,688 € 1,153 € 890,425
12 € 890,425 € 35,965 € 110,333 € 11,497 € 14,822 € 1,544 € 1,038,505
13 € 1,038,505 € 35,965 € 127,969 € 14,806 € 17,192 € 1,989 € 1,202,836
14 € 1,202,836 € 35,965 € 147,541 € 18,562 € 19,821 € 2,494 € 1,385,107
15 € 1,385,107 € 35,965 € 169,250 € 22,826 € 22,737 € 3,067 € 1,587,166
16 € 1,587,166 € 35,965 € 193,315 € 27,586 € 25,970 € 3,706 € 1,811,124
17 € 1,811,124 € 35,965 € 219,988 € 32,861 € 29,553 € 4,415 € 2,059,355
18 € 2,059,355 € 35,965 € 249,553 € 38,724 € 33,525 € 5,202 € 2,334,472
19 € 2,334,472 € 35,965 € 282,319 € 45,237 € 37,927 € 6,077 € 2,639,370
20 € 2,639,370 € 35,965 € 318,632 € 700,513* € 42,805 € 94,108* € 2,242,152
ETF growth

(*) assumes all remaining exit taxes for the 20 years is applied in the final year for like for like after tax comparison

Investment Trust Growth

YearFundAnnual SavingsGainCGTDividendsTaxTotal
1  € 35,718 € 4,065  € 571 € 297 € 40,057
2 € 40,057 € 35,718 € 8,623  € 1,212 € 630 € 84,980
3 € 84,980 € 35,718 € 13,735  € 1,931 € 1,004 € 135,361
4 € 135,361 € 35,718 € 19,469  € 2,737 € 1,423 € 191,861
5 € 191,861 € 35,718 € 25,899  € 3,641 € 1,893 € 255,226
6 € 255,226 € 35,718 € 33,109  € 4,655 € 2,421 € 326,287
7 € 326,287 € 35,718 € 41,196  € 5,792 € 3,012 € 405,982
8 € 405,982 € 35,718 € 50,265  € 7,067 € 3,675 € 495,357
9 € 495,357 € 35,718 € 60,436  € 8,497 € 4,419 € 595,591
10 € 595,591 € 35,718 € 71,843  € 10,101 € 5,252 € 708,000
11 € 708,000 € 35,718 € 84,635  € 11,899 € 6,188 € 834,065
12 € 834,065 € 35,718 € 98,981  € 13,917 € 7,237 € 975,444
13 € 975,444 € 35,718 € 115,070  € 16,179 € 8,413 € 1,133,998
14 € 1,133,998 € 35,718 € 133,114  € 18,715 € 9,732 € 1,311,813
15 € 1,311,813 € 35,718 € 153,349  € 21,560 € 11,211 € 1,511,229
16 € 1,511,229 € 35,718 € 176,043  € 24,751 € 12,871 € 1,734,870
17 € 1,734,870 € 35,718 € 201,493  € 28,329 € 14,731 € 1,985,679
18 € 1,985,679 € 35,718 € 230,035  € 32,342 € 16,818 € 2,266,956
19 € 2,266,956 € 35,718 € 262,044  € 36,843 € 19,158 € 2,582,403
20 € 2,582,403 € 35,718 € 297,942 € 686,845* € 41,890 € 21,783 € 2,248,876
Investment Trust Growth

(*) assumes all capital gains taxes for the 20 years is applied in the final year for like for like after tax comparison

8 thoughts on “How Investment Trusts compare to ETFs”

  1. “I don’t really care if my portfolio is worth 1 million or 10 million. Enough is enough for me.”
    – I absolutely love that! Very well put Meagan.

    Reply

  2. Hi,

    I’m a bit puzzled by the ETF calculation.

    How is the exit tax on year 8 only 1414 euro? Could you show step by step where that figure comes from please?

    By my own calculations the effect of deemed disposal is far more dramatic than that and indeed why it destroys compounding long term.

    So on year 1 you saved up and invested lump sum of 35k. Index grows about 10% a year, so 7 years later you basically double your year 1 money:

    35k*1.1^7 = 68k

    so your gain on year 8 for the investment on year 1 is 33k.

    Thus DD tax at 41% is:

    33k*0.41 = 13.53k

    So you need to subtract at least 13.53k out of your fund on year 8 to cover the tax.

    Deemed disposal absolutely destroys compounding, saying otherwise is misleading at best, there’s no way two investments that grow at same rate will have basically same value in the end if one of them is DD taxed. Intuitively doesn’t make sense. Let’s look at another numbers example.

    Let’s say we invest 1 euro and our investment doubles every 8 years (typical market return at 10% CAGR):

    DD case:
    year 1: 1 euro

    year 8: 1*2 = 2 euro -> 1 euro profit
    Tax due, 1 * 0.41 = 0.41
    We take the tax out of the fund so now left with 1.59
    Total end of year 1: 1.59

    year 16: 1.59 * 2 = 3.18 euro
    In calculating the second deemed disposal, we must use the assumption that the first one didn’t occur, so we have to add the 0.41 back to the fund value.
    We add 3.18 with 0.41 less the investment amount of 1, which gives us a taxable amount of:

    3.18 + 0.41 – 1 = 2.59

    Tax due, 2.59 * 0.41 = 1.0619

    We subtract the DD tax we have already paid in year 8 again to get net tax due:
    1.0619 – 0.41 = 0.6519

    We pay the tax out of the fund, so the final fund value on year 16 is:
    3.18 – 0.6519 = 2.5281 euro

    Note: source for calculations and methodology https://www.bluewaterfp.ie/investments/calculating-deemed-disposal-on-a-long-term-investment/

    year 24: 2.5281 * 2 = 5.0562
    Same methodology as above, add back paid tax, subtract cost basis to get net profit for tax:
    5.0562 + 1.0619 – 1 = 5.1181

    Tax due, 5.0562 * 0.41 = 2.073042

    We subtract the DD tax we have already paid in year 8 & 16 again to get net tax due:
    2.073042 – 1.0619 = 1.011142

    We pay the tax out of the fund, so the final fund value on year 24 is:
    5.0562 – 1.011142 = 4.045058 euro

    So lets say we exit the investment at year 24, as we paid all the tax already then the final value is the 4.045058 euro

    Now let’s compare with non DD case.

    Non DD case:

    year 1: 1 euro
    year 8: 1*2 = 2 euro
    year 16: 2 * 2 = 4 euro
    year 24: 4 * 2 = 8 euro

    So likewise, we exit here at year 24. Total profit is 8 – 1 = 7 euro
    Tax due at 33% CGT, 7 * 0.33 = 2.31 euro

    Final value 8 – 2.31 = 5.69 euro

    Comparison:

    final value: DD vs non DD
    year 1: 1 vs 1
    year 8: 1.59 vs 2
    year 16: 3.18 vs 4
    year 24: 4.045 vs 8 (or 5.69 if we sell)

    assuming we sell non DD at year 24, it’s about 40% better off than DD case.
    5.69/4.045 = 1.40667

    There is simply no way value of DD taxed investment is anywhere close to non DD taxed investment at the time of final disposal.

    So please let us know how is the exit tax on year 8 only 1414 euro? Could you show step by step where that figure comes from please?

    I hope I won’t come off too militant here, just trying to help fix a potentially what I consider to be very dangerous and misleading information as people are looking for at long term view here and mistakes decades down the line could be costly to say the least – and it won’t be apparent till decade later! So let’s put them on the right path!

    I think it’s fantastic to spread financial awareness, especially in Ireland and you’re blog is a good resource for that! I hope you’ll understand that I’m being tough because I care and want to help improve things!

    Cause at the end of the day, you are in a responsible position here. No matter how many disclaimers you make that “this is not financial advice, speak to professional” etc. etc. The reality is that people who come to this blog are likely here as alternative to talking to a financial advisor and at least some of then will basically do what you say.

    In the end, we’re all here to help each other so let’s do that, let’s get to the bottom of this DD tax calculation and help make Ireland a more financially literate place 🙂

    Reply

    • Hi EM, Thanks for your comment. I appreciate that you are trying to ensure accuracy. I read the bluewater financial post and in that example it does not clarify whether the 100k is a lump sum or accumulated gradually. Based on my understanding of the deemed disposal rule, the article is making an assumption that the 100k is a lump sum investment and showing how that would be treated over 20 years. If you read the actual tax documentation from Revenue, deemed disposal is defined as “Finance Act 2006 introduced a new chargeable event and provided that a disposal of units is deemed to occur on the ending of an eight-year period following the acquisition of the units” – see page 13 of this doc: https://www.revenue.ie/en/tax-professionals/tdm/income-tax-capital-gains-tax-corporation-tax/part-27/27-01a-02.pdf – as they have stated “following the acquisition of the units” – this to me means that you are only charged deemed disposal on the units you purchased 8 years ago NOT ALL units purchased WITHIN the last 8 years. This is the basis of my understanding in the calculations in the article.

      Reply

      • Hey Meagan,

        good to see there’s no disagreement then, your assumptions are the same as mine. All the calculations I’ve done have been with those exact assumptions.

        So on year 1 you saved up and invested lump sum of 35965. So we’re keeping it simple and are assuming no further investments were made after year 1.

        You said Index grows about 11.91% a year, ok so 7 years later you basically double your year 1 money:

        35,965*1.1191^7 = 79061

        so your gain on year 8 for the investment from year 1 is:
        79061 – 35965 = 43096

        Thus DD tax at 41% is:
        43096*0.41 = 17670

        17670 is much more than 1414 that you’ve provided.

        So I really don’t understand where 1414 came from, if you could please show where that came from?

        Thanks

        Reply

        • Hi EM, Thanks for clarifying, yes I see what you are saying. It appears I wrote this article before I fully understood the application – I have updated my calculators since and they match your example more closely although I did not not remember to come back and recheck findings against older articles. Thanks for the push. I will update.

          Reply

          • Thanks, Meagan

            Sad though.

            Took a while to figure out this DD stuff as information is scant, scattered and often contradicting. I was hoping that I missed something, that things weren’t as bad as they seemed. 😕

            Thanks

          • Hi Meagan,

            Just curious – it seems like you would be 40% better off if you invested in an Investment Trust based on these updates / corrections which is much better than you thought in your original blog post. So are you continuing to invest in ETFs or will you switch to ITs?

          • Haven’t gotten around to updating the calc/post yet but I don’t think it’s as high as 40% difference (though likely still substantial enough). For now yes I am sticking with ETFs as I have faith that the deemed disposals will be revised in the coming years and/or Investment Trusts will be brought in line with ETFs. Obviously no way to know as I’ve said before I don’t care if I have 1 million or 10 million, if I have enough to get by then I don’t need any more and all the other reasons stated in the article still stand in terms of diversity, risk and currency.

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