There is no doubt that stocks can be a great investment. Compared to other asset classes they are pretty easy to acquire, there is no need for tens of thousands of euros for a downpayment, they don’t require debt and are very passive. They give us an opportunity to be invested in businesses without having to create those businesses. Last ten years were great for the stock market, even the coronavirus crisis didn’t depress the market for long. This doesn’t mean that the great returns will continue forever, but still the long term outlook for the overall market is great (long term stocks tend to go up as economies grow) especially if we look globally.
The problem is that while picking the individual stocks, you might not be able to capture the overall market trend. You might pick the stocks wrong and the price might drop and never recover, or the company simply gets bankrupt. You might pick up a great company, buy it cheap (below intrinsic value), but still not earn money on it for many years. There is a lot of uncertainty in the stock market and investments in individual stocks are regarded especially risky. Maybe you could beat the market with your individual investments, but most likely you won’t. Many professionals don’t manage to do it. However, even if individual bets usually don’t work that great, the markets as a whole are usually doing pretty well.
Argument for Index fund ETFs
This is why people recommend investing in stock indexes that track the whole markets or big chunks of the markets. Instead of picking one stock you pick and index investment that represents shares in hundreds if not thousands businesses at the same time. Usually you invest in an index by investing into a fund, there are various types of funds, but the most typical for indexes are ETFs - ETF means “exchange traded fund”. Not all ETFs are index funds, but most of the index funds are ETFs.
Index funds are passive (there isn’t a manager picking individual investments) and they generally have low fees. On the other hand many typical mutual funds (non indexes) available in Ireland have high fees, there are entry fees (often 1% of value, sometimes even as outrageous as 3%) and ongoing fees of 1-2% of each year. Read about fees on the CCPE website. There are many financial advisors who earn comissions from these products and sell them to people, even though they often are more expensive and have worse results than alternatives. You should always do your reasearch! The fees for index fund ETFs are generally lower, in Europe typical would be 0.1%-0.5% a year, but there are cheaper and more expensive ones, see an example of a ETF. Before you decide on a specific ETF, do your reasearch using sites like justetf, you might be able to find a cheaper equivalent. You probably also want the ETF to be domiciled in Ireland.
Another cool feature of ETFs is that if one can pick an “accumulating” ETF that can accumulate the dividends. Dividends are profits that some companies pay to shareholders on a regular schedule. However it is not always useful to get a payout. For long term investors that don’t need income right now, reinvesting makes more sense. Accumulating ETFs automatically reinvest the dividends. One could also reinvest the dividends themselves after receiving them, but they would have to be taxed at a higher rate. So the accumulating index fund ETFs are more tax efficient and convenient for investors that don’t need the money now!
Here is a summary of benefits of index fund ETFs:
- Captures overall market trend
- Great diversification & simplicity
- Low fees compared to actively managed funds
- Accumulates dividends (if using an “accumulating” fund)
Tax downsides of investing in ETFs in Ireland (Ireland and EU domiciled ones)
The decision to put most of your investment money into index tracking ETFs would be easy, if not their tax treatment. The taxes are high and complicated. And if you google for ETFs tax ireland you will find scary articles like this one.
The downsides of the ETF tax treatment in Ireland are:
- High tax rate of 41%
- deemed disposal tax - complicated, disrupts compounding
- inability to use losses to offset gains
The tax rate is 41% and that applies to both gains and dividends, your other earnings don’t matter, the rate is always the same. For normal stocks (not funds) the capital gain tax is 33% (there is an exemption for first 1270 of gain) and dividends are taxed like income (e.g. if you are a high earner then the tax from the dividends can be 52%).
For the ETFs, there is also a “deemed disposal tax”, that you pay even if you don’t sell the fund every 8 year you hold it, and it’s also 41%. If you later sell the ETF then you can deduct the tax you have already paid for the deemed gains. Well, is the 41% that much worse than 33%? The great thing about not paying the taxes until the last moment as one can do with normal shares is that the shares can compound uninterrupted for many years. If your outlook is short, then that doesn’t matter much, but most people invest for a long term and then it starts to matter. Especially if the deemed disposal would hit you at a bad moment and you would pay a lot of tax and then the shares would drop. The price drop leads us to another drawback of ETF taxation in Ireland.
It turns out that in Ireland, you can’t use losses on ETFs to offset gains on ETFs. This was surprising to me to discover. Because this is normal for Capital Gains from stock trading. With stocks it works as follows:
Let’s imagine that you buy 3 different stocks on different days one unit each time and you pay different prices, e.g. 200, 100, 300. Then you sell all the units at a price of 270 for whatever reason (let’s say because you have to). So you bought for 600 and sold for 810, your gain would be 210.
Now, if those were funds, it would be different since one share had a loss and that loss can’t be used to offset gains! So your chargeable gain is instead 170 + 70 = 240. Which is significantly higher.
And let’s say that you were very unlucky and you had to sell your investment when the price dropped. Then instead of gains, you just have pure losses. With stocks you can carry those loses forward to the next tax year to offset your next year gains.
How to get (some) advantages of ETFs without actually holding ETFs and avoid the tax downsides
So, how could one get most of the benefits of ETFs without most of the downsides? It is possible to achieve a low cost and highly diversified portfolio without ETFs. Well, it won’t be exactly the same, but it should be correlated and even if the performance is not the same on average, the long term return might turn out very similar. First, a disclaimer: it’s definitely a much more risky approach than just a simple ETF index fund portfolio and I wouldn’t recommend it to everyone, but it’s something worth exploring.
The overall method is as follows:
- Combine large cap stocks
- add some stock sampling diversified across sectors and potentially countries
- (optional) prefer internally diversified companies
- (optional) add some investment trusts for greater diversification
For selecting individual stock take a look at what is in SP500 one of the most popular US stock indices. The global equity market is dominated by the US stocks. In turn the US market is dominated by the biggest stocks (10 largest companies in the index account for 26% of the market capitalization of the index) so if you just pick the biggest stocks in SP500 and sample a bunch of other ones, you should have a similar performance to SP500. How much one would like to invest in each individual stock would depend on their risk tolerance, but you shouldn’t put more than 5% in each individual holding, so you should have at least 20 investments. Since one likely wouldn’t be having thousands of individual stocks, sampling or stock picking comes to a rescue.
If you care about diversification, make sure that you own stocks from different sectors. For an example of sectors and their proportion in the market take a look at an article like this one.
Alternatively, you can get very diversified through companies that are internally diversified for example: Berkshire Hathaway is a holding company that owes lots of companies and stocks internally. Also if what you care about is global exposure, lots of big US companies have clients globally.
Anyway, even though there are a lot of great options, still the stock selection is the hardest part of building the custom portfolio. On top of that as one invests regularly, one has to make even more decisions, which of the existing stocks to buy more of or if to buy a new holding. It quickly gets quite complicated.
Stocks outside of US and Investment Trusts
When it comes to international exposure the stock sampling is much harder, because you will need many more stocks. This is where investment trusts come handy.
Investment trusts are investment companies listed on stock exchanges, most of them in the UK. They are similar to mutual funds in a way that they usually use active management, but they are different because the number of shares is limited and for the Irish tax purposes they are treated like normal stocks. You can find a great article here that compares the to other types of funds: Another interesting thing about the investment trusts is that they can use “gearing”, which basically means leverage and amplify gains this way. There are all sorts of investment trusts that cover different asset classes (not only stocks but also bonds and commodities), sectors and strategies. Due to the active management aspect, you shouldn’t just pick a random trust you find somewhere. You need to do your research. My favorite resource for researching the investment trusts is trustnet.com. I could definitely write another article just about the investment trusts!
Buying individual stocks when some stocks are very expensive: fractional shares
Do you know that one share of BRK.A is valued more than 300k USD? Luckily there is BRK.B which is the same company, but at a more accessible price, but still the problem is that some stocks are quite pricey. E.g. today Amazon stock is valued at 3,306.73 USD. So if you want to buy an amazon stock, you need to pay multiples of that or use fractional shares.
Some brokers allow you to buy fractions of shares, which is called “fractional shares”.
They aren’t available everywhere (e.g. degiro doesn’t support it right now), but can prove very useful. Fractional shares could help you build much closer replica of a specific index (e.g. SP500).
My strategy for last 2 years of individual stock portfolio
So that was a lot of tips, are there any crazy enough people who would put such a plan into action? Turns out they are, I have been building such a portfolio for more than two years. I will start with my specific strategy and then describe the current portfolio state and results.
How much I invest and when:
- regular monthly transfers (certain percent of my paycheck)
- occasional lump sums (when I sell my employer stock grants or get a bonus)
How I picked my investments:
- Sampling of SP 500
- Couple (5) of hand picked non US stocks (15% of my portfolio) - diverse sectors, companies with great balance sheets
- Some Investment trusts (10% of my portfolio) based on my diversification needs
I spend quite some time reading about the company and looking at its stock before I add it to the portfolio, and if it has really bad prospects, business that I don’t agree with (e.g. selling cigarettes or gambling) or it looks very overvalued I don’t pick it and move on. I have a slight bias for non dividend companies, but I do have some high dividend payers as well.
As of now my portfolio has 30 holdings.
How I pick in what to invest at a given moment:
- I would either decide to add more to individual stocks or to some investment trusts
- For individual stocks I would sort them buy amount owned and would randomly pick 2 or 3 out of first 10 that I have the smallest amount of. This type of approach incentives avoiding “I know what will go up next” traps and equally sized portfolio.
- I avoid purchases smaller than 400 euro at the time, because I don’t want to spend too much on fees
My odd bets:
My best bets so far:
Docusign - 4-exed (I sold it and diversified)
Brookfield Renewable Corp - 2-exed (still holding it)
Worst bets so far:
Columbia sportswear (~-9%), but I am still happy holding it
The trusts I have are:
Emerging markets growth:
Those investment trusts have yearly expenses of about ~1%.
I own those trusts because I wanted more European exposure and I am bullish on emerging markets. I also believe that investing in emerging markets can actually benefit from active management, because there is much more volatility in those markets and additional screening and research is valuable.
Here are some key stats about my portfolio:
- Current value ~90k Euro
- Invested 71.5k
- Gain 18.5k (price difference + dividends)
It’s hard to calculate yearly return since I keep adding more and more to the portfolio over time (it’s commonly called dollar cost averaging, in this case euro cost averaging), however the total return is ~25%. Bear in mind that most of my investments are in dollars and the strength of the dollar has fallen a bit lately and that we recently had a big dip in the market and I have been investing during the dip as well.
When I compare the results of this portofio to my work pension in the Irish Life fund, the Irish Life fund looks much worse than that (due to smaller proportion being in equities). The returns also look pretty great compared to what one could achieve with real estate.
This portfolio is subject to Capital Gains Tax of 33%, no deemed disposal tax, I can use yearly tax allowance of 1270 for gains, I can offset the gains with the losses and do things like tax loss harvesting. The dividends are taxed at the income tax rate which for now is 52% in my case, but if my income drops, that rate could be significantly lower. The portfolio yields no more than 2% in dividends, so that doesn’t impact the return to high.
Tips for running a DIY portfolio
The hard part of runnng a DIY portfolio is that you yourself might be your worst enemy. A common trap is that it’s easy to get excited with some hot stock tip and make some bad decisions. To prevent that, you need to be disciplined and have a very clear strategy and stick to it.
If you seriously want to try this route, start an investing journal where you write down your notes, intended trades and transactions. Write down what is your strategy exactly, when you buy, how much you buy and how you will decide what to buy next. Separate researching from buying - e.g. write down your research notes in your investment journal, put the stocks in a stock “watchlist” spreadsheet. Execute only according to your strategy. Plan things in advance.
It’s ok to have some “play money” for small bets, but it should be a clear part of your strategy and not decided on the spur of the moment.
I have experimented with a custom built long term portfolio for more than two years. It has performed great so far, but I would not attribute it to particular skill, but likely to general market trends and luck. It is definitely a risky and complex approach and I am planning to add some ETFs to my portfolio starting in 2021. For sure the DIY approach gives you a lot more control over your investments, but it requires a lot more research and decisions. And you might have poor results in the future. I have learned a lot in the process of running my DIY portfolio and I think it was a good idea overall, but not everyone is such a financial nerd as I am.
The tax situation is also not written in stone, in 20 years the tax law might look quite different or I might not live in Ireland anymore. As with the market, it’s hard to predict the future.
I hoped you like this article, please feel free to ask me questions in the comments.