Scenario 1: Invest 200€/month in average growth year

• Invest 200€/month in Irish domiciled ETFs on the last day of each month
• ETFs make gains of 7.91% (assumes 10% performance minus 0.19% fees minus 1.9% inflation)
• ETFs make 2% in dividends
• Purchase charges: Degiro charge 4€/trade plus 0.05% of the value purchased up to a max of 60€.*

*Degiro have a number of commission free ETFs where you can buy up to 200 different ETFs each month for free. If you determine your portfolio to use these ETFs it doesn’t matter how frequently you buy.

Other fees I have found are applied depending on the country the fund is based.

Calculations:

• Fees: 200€/month = 4.10€ in fees per month = 49.20€/year (2.05% net fees per year for your 2,400€ invested) – investing 195.90€/month
• Gains: 102€ (11 of the 12 months as you lost out on gains from Jan 1-Jan 30)
• Dividends: 26€ (11 months)

Value after 12 months: 2,481€

Scenario 2: Invest 2,400€ at the end of the year in average growth year

• Invest 2,400€ lump sum on Dec 31 in Irish domiciled ETFs
• ETFs make no gains as invested at end of the year
• ETFs make no dividends as invested at end of the year
• Purchase charges: Degiro charge 4€/trade plus 0.05% of the value purchased up to a max of 60€.*

Calculations:

Fees: 2,400€ lump sum per year = 5.2€/year in fees (net fees for the year or 0.21% net fees)

Value on Dec 31: 2,400€ minus 5.20€ = 2,394.80€ after fees.

Scenario 3: Invest 200€/month in commission free ETFs in average growth year

If you go with the free commission ETFs then you end up with the full 2,533€.

Scenario 4: Invest 200€/month in bear market year

If it was a particularly bad year, for example you started investing in October of 2007 in the SPDR S&P 500 (SPY) and through the year you lost 37.4% minus 0.19% fees and 1.9% inflation but also made 2% in dividends, your end portfolio would be 1,924€. This is 471€ LESS than if you had invested one lump sum at the end of the year.

I looked at the historical trends of the SPDR S&P 500 (SPY) for Nov 2007 to Oct 2008 (as it’s been in operation since 1993) and figured that if you were investing monthly in that time frame you would have 18 ETFs at the end of the year (taking currency out of the equation for simplicity sake). The prices went down every month and were at their lowest on the last month at 96.83$. Without investing anymore after that date, based on today’s value of 286.28$ your 2,400 would be worth 5,153.

If you’d waited to purchase the lump sum on the last month your 2,394€ would have bought you 24 ETFs, which would be valued at 6,870 today (1,717 MORE than if you’d invested monthly).

Scenario 5: Invest 200€/month in bull market year

If it was a good year, for example you started investing in October of 2012 and through the year you gained 24.4% minus 0.19% fees and 1.9% inflation and also made 2% in dividends, your end portfolio would be 2,685€. This is 290€ MORE than if you had invested one lump sum at the end of the year.

Looking at the historical trends of the SPDR S&P 500 (SPY) for Oct 2012 to Oct 2013 by investing monthly in that time frame you would have 14 ETFs at the end of the year (taking currency out of the equation for simplicity sake). The prices went up almost every month and were at their highest on the last month at 175.79$. Without investing anymore after that date, based on today’s value of 286.28$ your 2,400 would be worth 4,263.

If you’d waited to purchase the lump sum on the last month your 2,394€ would have bought you 13 ETFs, which would be valued at 3,900 today (363 LESS than if you’d invested monthly).

Scenario 6: Invest 200€/month over 2 years with one year in bull market and one year in bear market

BUT since you’re in this for the long haul, how does euro cost averaging fare in these 2 years if you invested monthly during both the bear and bull market years?

After 24 months your 200€/month would leave you with 5,132€.

If you invested a lump sum at the end of each year you would have 4,789.60€ (342.40€ LESS than investing through the year with higher transaction fees).

Number of ETFs owned in each approach?

Looking at the two scenarios, buying monthly over 2 years you would own 33 ETFs. Buying in lump sums once a year you would own 38 ETFs. At today’s value, without investing any further the lump sum approach would leave you with 1,145€ more in market share.

Summary

What this demonstrates is that investing every month is the better option especially if you are investing in commission free ETFs. It also goes to show that time IN the market is better than timing the market. You also have the benefit of euro cost averaging where some months you may lose money and others you may gain ultimately averaging out over the long term.

In the case where your market share was less by investing monthly, the bear and bull market examples were two extreme years to make a point. Over the long term, at least historically, over the last 50 years, bear markets run for an average of 1 year while bull markets run for an average of 6. In the 1 year of bear market though it is typical that it will make almost double the losses than the bear market will make gains but for the one year you are making losses, if you keep investing, the following 6 years you will be making smaller gains and euro cost averaging will win out.

Other considerations

The above is purely the mathematical side of investing monthly vs annually. As with everything else to do with investing, this needs to balance out against the individual’s emotional approach to money.

If you know yourself to be bad at saving and would be tempted to access a lump sum of cash while waiting to invest it at the end of the year, it might be best for your to automatically have it invested each month to safeguard it from yourself.

The other side is the administrative side. From a tax reporting perspective I’ve read that investing small amounts on a monthly basis can make it difficult to calculate the taxes owed at the end of the year. However, I have not been able to confirm this yet as it will be my first year to file taxes this year. From what I can tell, Degiro (and likely other brokers) provide you with an annual report for the purposes of tax which outlines clearly what gains and dividends you have made through the year. This makes it quite simple to calculate but I haven’t been investing regularly so I’ll have to keep you posted on how the tax filing goes.

Also the fees used in this example are probably one of the lowest in the market. If you are using a bricks and mortar broker your transactions fees will likely be much higher which may swing the assumptions in this article in the other direction.

On a high level, even though you pay more tax with an ETF, your real rate of return isn’t much lower than stocks as stocks have higher purchase costs. This results in a somewhat comparable portfolio even though you will have paid more in taxes.

This post has been edited as when I first did the analysis, I forgot to drag the formula down to include the stock dividends. This resulted in ETFs winning in the comparison. That’s what you get for doing analysis at 10PM!

An added benefit of this blog is that my analysis and assumptions can be peer reviewed, usually within a day or so of posting. It’s so great to be part of an active community that’s as interested as me in finance.

Read on for the details.

ETF Pros:

• ETF’s are index funds which are made up of hundreds if not thousands of different stocks/companies. This gives huge diversification with little effort.
• They can be a set and forget and lazy investment option meaning you don’t need to read up on company performance reports and continually watch individual stocks.
• They have low fund management fees.
• They are cheap to buy in terms of commissions. Brokers often have some ETF’s which you can buy commission free.

ETF Cons:

• High taxes
  • 41% on gains
  • 41% on dividends
• Subject to 8 year deemed disposal rule
  • Reduces compounding effect
  • Increases tax filing burden
• They do not allow you to carry forward any losses to be used against future gains

ETFs are often down played or even avoided due to their high taxation in Ireland as well as their being subject to the deemed disposal rule.

A few years ago we used to have access to US ETFs which had a better tax treatment similar to stocks.

When I first started reading about investing I was annoyed that we no longer had this option and considered trying to replicate the ETF make-up manually by buying the top 10 stocks in each in order to avail of the better tax treatments.

This post will show why I’m no longer going to worry myself with this annoyance.

Deemed disposal

The concept of deemed disposals was brought in in 2006. The idea is that on the 8th anniversary of you holding an investment you must pretend to have sold it at the market value in that year. You must pay the exit tax on those gains.

This tax acts as a credit which you will use against your actual sale of the ETFs. If the market value is worth more when you sell than it was when you paid your deemed disposal, you will pay the difference. If it is worth less, you will get a refund.

If you hold distributing ETFs which pay out dividends each year, then you will need to pay taxes each year from year 1, regardless of if you reinvest those funds into the same ETFs or if you withdraw the cash for current use.

If you hold accumulating ETFs which automatically reinvest the dividends into the same ETF, you will need to pay the exit tax in the 8th year on both the gains and the dividends.

Worth noting is that exit tax was once as low as 23% from 2001-2008. Fund managers are lobbying to the government to bring the current rates of 41% back down at least in line with CGT and DIRT at 33%.

If this were to happen, ETF’s would fare better than stocks.

Stock Pros:

• Lower taxes:
  • 33% on gains
  • Marginal tax rate+USC+PRSI on dividends
    • You would need to be earning 120,000€ per person in order to have a net tax rate of 41% or higher so anything below this will mean you pay less on stock dividends than ETFs
• You can carry forward losses to offset taxes on future gains
• You get a tax exemption of 1,290€ on gains per year any year you sell stocks

Stock Cons:

• Expensive to purchase
  • 1% stamp duty on Irish shares, 0.5% stamp duty on UK shares. Some shares are exempt from stamp duty, such as Irish shares listed on the Enterprise Securities Market (an offshoot of the Irish Stock Exchange).
  • 2.40€ charge to buy 1,000€ worth of shares
• Lack of diversification
• Active reviews, research and monitoring required

This article shows how the assumptions I am using are the lowest possible in terms of fees for buying stocks. If you are using expensive brokers with annual account fees and high purchase charges this example would be even further exacerbated.

Comparison

Assumptions

• Investing 12,000€/year (1,000€/month) in ETFs
• Investing 11,851.20€/year (987.60€/month) in stocks due to there being 1% stamp duty and a 2.40€ commission for purchasing 1,000€ of shares on Degiro. This is MUCH higher on some other brokers as this article points out
• ETF performance 100% equities at 10% minus 0.19% management fees minus 1.9% inflation = 7.91% real rate of return
• Stock performance at 10% minus 1.9% inflation = 8.1% real rate of return
• Dividends for both 2% paid from year 1 (non-accumulating)
• Marginal net tax rate for stock dividends = 26% (gross income of 50,000€ for single person or 100,000€/couple)
• 20 year investment term
• Selling all assets at the end of the 20th year and paying all taxes due.
  • Although this is highly unlikely it is the only way I could compare the net effect of all taxes simply. This approach doesn’t take into account the stock gain exemption either which would also increase the stock output if selling little amounts each year of retirement.
  • I might look at a more comprehensive analysis including staged withdrawals at some point.

Outcome

So over 20 years, you end up with 70,291€ more in stocks than you would in ETFs with 28,000 less in taxes. This is a difference of 3,500€/year or the stocks earning a real rate of return of 0.31% more than the ETFs.

If you change any of the assumptions this comparison could swing in the other direction.

Even though stocks fare better, for now, I’m laying to rest my annoyance over not being able to get access to better tax rates for ETFs as I feel the pros of diversification and passive investing outweigh the potential additional gains of a stock portfolio.

I’m also hopeful that the hedge funds lobbying to bring the exit tax rates back in line with DIRT and CGT will be successful.

If that were to happen the above scenario would result in the ETF having 550,000€ as the end portfolio, paying 152,000€ in tax. And resulting in only 27,000€ less than the stock portfolio (or 1,350€ less per year).

What do you think? Have I missed something?