Ever considered an Exchange Traded Fund (ETF) only portfolio? For many DIY investors, it could be the cheapest way of owning a diversified portfolio of index trackers.
Now that the era of passive investors being subsidised by their wide-eyed active investing cousins is over, it is still possible to avoid platform charges altogether by owning a portfolio invested 100% in ETFs.
Execution-only brokers TD Direct Investing and Sippdeal both currently waive platform fees for ETFs. You’ll only pay broker fees when you trade and even that hit can be softened by exploiting regular investing schemes.
More on that below.
So what would an ETF-only portfolio1 look like? Here’s a pretty diversified slate:
| Asset class | ETF name | Ticker | OCF (%) |
| UK equity* | SPDR FTSE UK All Share | FTAL | 0.3 |
| International** | Vanguard FTSE All World | VWRL | 0.25 |
| Emerging markets | Vanguard FTSE Emerging Markets | VFEM | 0.45 |
| Global property | HSBC FTSE EPRA/NAREIT Developed | HPRD | 0.4 |
| Government bonds (Gilts) | Vanguard UK Government Bond | VGOV | 0.12 |
| Index-linked gov bonds | DBX iBoxx UK Gilt Inflation Linked | XBUI | 0.2 |
* A cheaper UK equity fund is VUKE – Vanguard’s FTSE 100 ETF (OCF 0.1%).
** VWRL is approximately 10% in emerging markets. Add VFEM for a stronger dose.
Buyer beware
Despite all this platform fee chicanery, an ETF-only portfolio won’t always make sense. It’s only worthwhile if the portfolio’s total cost (i.e. the weighted sum of the fund OCFs) is less than the platform fee you’d have paid for a portfolio including funds (plus the difference in trading charges).
If you’re stuck on TD Direct then that’s easy. TD’s 0.35% platform fee2 means that every fund you own effectively costs 0.35% more than its advertised OCF. That’s a high bar to get over and you’d have to own a portfolio smaller than around £10,000 (or be a trading fiend) not to do better in ETFs.
On Sippdeal you pay a fixed platform charge of £50 per year plus trading fees on all investments. If your ETF portfolio’s average OCF siphons off £50 more than its fund-based counterpart then it’s not worth it.
The bigger your portfolio, the less likely you are to benefit because it’s quite common for index funds to be cheaper than ETFs in the UK, unlike the US.
Charles Stanley overlooks its 0.25% fee on ETFs if you trade six times or more every six months. But a flat £10 dealing charge means you’re better off with TD Direct.
Sippdeal and TD Direct are both better prospects for an ETF-only portfolio because they enable you to set up a regular investment scheme that only costs £1.50 per purchase.
Gaming regular investment schemes
To keep costs down, I’d buy one ETF every month for my portfolio. For example, I’d buy my entire year’s worth of property ETF in June and my FTSE All Share ETF in July and so on. There’s no need to drip-feed into every ETF every month.
Your broker can’t make you invest every month either, so once you’ve had your fill, just cancel your regular order, and replenish your reserves if cash is tight.
It doesn’t matter to me that regular investing means I buy on a fixed date in the month that’s decreed by the broker. Passive investors don’t believe in market timing, so I wouldn’t lose sleep over picking my moments.
Sell orders are conducted at full price with these regular services, but if you rebalance with new money then you can largely avoid selling until your portfolio gets mahoosive. (Some brokers, notably Halifax, also offer monthly special deals where their usual trading fees are discounted for a few hours. You could time your rebalancing to exploit this).
The technical differences between ETFs and funds are practically negligible for most passive investors, too. The hoo-ha about synthetic ETFs was overblown, and I don’t have any qualms about using them when they best track the asset class I want a piece of.
No straight answers
As ever, by the time I’ve written up an investing stratagem, I’ve thought of half a dozen ways to undermine it and I can’t help but ‘fess them up. Such is the tangled web of investing!
Personal circumstances are everything in the field of cost bullet-proofing and the chances are that most small investors will do better in funds with Charles Stanley Direct, if their portfolio is likely to remain under £20,000 for a good stretch.
Meanwhile large investors will generally profit from choosing a fixed fee broker and investing in the cheapest trackers they can get – whether a fund or an ETF.
Let our broker comparison table be your guide.
The best advice is not to sweat it too much. Low cost is good, but endlessly fiddling in pursuit of perfection is a waste of life.
Take it steady,
The Accumulator
I’d rather buy gilts and hold to maturity than buy an ETF. It’s what we’ve done in the past with good results. But then anyone can be a bond genius when interest rates are falling.
1. For several reasons, I went all ETFs after last year’s debacle at Interactive Investor necessitated a change of broker.
2. Been very happy so far, except for one thing. One of my ETFs was delisted from the LSE, eventually liquidated. I was in the dark about all this until the cash proceeds suddenly arrived in my account with the current broker. The issuer has in fact left the London market, removing their UK website as well. Very poor communication – okay, none at all. But what I really want to highlight is this: it meant I was out of the market for several days against my choice. Also, I was forced to incur transaction costs buying a replacement ETF.
Darn, this post was meant to go up on Tuesday. I blame sunstroke! Or Pimms…
@The Accumulator
> “if their portfolio is likely to remain under £20,000 for a good stretch…”
I was wondering how many Monevator readers’ portfolios are below £20K? With the ISA limit at about £11.5K p.a. if you choose to use it all, and returns over the last year being rather good, I’d guess it is mainly those who are relatively new to the game. It might be fun to include one of those anonymous polls in a post sometime to find out? Purely for voyeuristic fun of course!
@ The Investor
> “this post was meant to go up on Tuesday”
LOL – so you are only human!
I used to have almost all of my holdings in ETFs, but when I started moving from Halifax Sharebuilder to Hargreaves Lansdown a few years ago (a move I’m happy about, despite what I’m about to say), I realised one of the drawbacks.
While many tracker funds have both an Income and Accumulation version, ETFs don’t! So if your ETF distributes dividends you have to pay trading costs for the dividend-reinvestment (assuming that’s what you want to do, but most of us do)
That’s fine with something like Halifax Sharebuilder: dividend reinvestment happens immediately and costs 2% with no minimum (used to be even less!)
However with Hargreaves Lansdown it’s 1% BUT with a minimum of £10 each time, and they only do it when the dividends have built up to £200. So for a £50 dividend payment per year you’re waiting a long time and then losing a lot in charges.
I have most of my holdings in HL now but I still have my ETFs with Halifax Sharebuilder for this reason.
So watch your trading costs for reinvestments if you head down the ETF route!!!!
I made mistake initially of not checking where the ETFs were domiciled. All the ETF’s listed by TA above are domiciled in Ireland so there is no additional withholding taxes. Goto UK website of Vanguard, ishares etc to check domicile location.
I believe only certain ETFs are allowed in ISA’s and SIPPs, dependent on domicile location ?
@AJ. i’m looking to open account with Halifax Sharebuilder, how does customer support compare with H & L ?
H & L is customer support excellent.
Regards,
Jon
@Jon The website is a complete nightmare compared to Hargreaves Lansdown but it DOES function and it has the advantage of the sharebuilder “regular investment” feature where you place a buy order, have to wait a few days, but then it goes through at only £1.50 trading cost! You can’t pick exactly when it goes through but for long-term buy and hold it’s perfect.
I only contacted support a couple of times when ETFs that I wanted to trade weren’t available through the cheap “sharebuilder” part of the site. The answered quickly and although they couldn’t really explain why some were and other virtually identical ones weren’t, they sometimes got them added for me so can’t complain!
It would be prudent to verify the dividend distribution of the Vanguard’s international ETFs. Although the ticker symbols are GBP denominated, I understand that some dividends are paid in USD. This only adds to cost (i.e. currency conversion) which can be high depending on broker. A more comprehensive discussion of this is on the Motley Fool Forum (http://boards.fool.co.uk/vanguard-etf-dividends-12838248.aspx?sort=whole#12838248)
@AJ There are accumulating ETFs! Confusingly the terminology is different:
Distributing – gives out the dividends
Capitalising – reinvests dividends. (sometimes called Total Return)
Things to be aware of:
– If your ETF doesn’t have reporting status and isn’t in an ISA, you will get stung for income tax on any gains! Avoid!
– You can’t hold foreign listed ETFs in an ISA
– Foreign listed ETFs are likely not to have reporting status anyway.
– ETFs are usually domiciled in Ireland or Switzerland to avoid Stamp duty even if they are listed in London.
– If they are listed anywhere else, they probably have withholding taxes. I think Lyxor or Easy ETF (France) are the only ones you might come across that fall into this category.
Greg
Finally, I’m pretty sure that capitalising ETFs allow all gains to be classed as capital gains, which is probably of interest to higher-rate taxpayers who hold them in taxable accounts.
(Oh and when I said Switzerland I meant Luxembourg! )
Unfortunately not all ETFs are available on Sippdeal’s low cost monthly investment – VHYL (Vanguard World High Yield ETF) is not availbale, whereas VWRL (Vanguard All World ETF) is. Maybe this point should be made to Sippdeal rather than here, but when I tried I was told that some are, and some aren’t!
i’m doing more-or-less this in a sippdeal SIPP. since it’s too small to justify paying the £50 per year platform fee.
when there’s more in there, i plan to start using some funds, and pay the platform fee. as that gives a bit more choice – e.g. i can’t see an ETF equivalent to the Vanguard Global Small-Cap Fund.
Interesting article as I have been looking at converting my Hargreaves Lansdown Unit trust income portfolio into an ETF portfolio. While doing the research for this I found a useful site for assessing ETF:
http://www.whichetf.co.uk/
It has a search facility for identifying suitable ETF’s for your portfolio.
@Ric — Yes, sadly full of a wealth of human foibles me. 😉
@greg- I think unfortunately your assumptions about the tax treatment of capitalising ETFs is mistaken – my understanding is that they are treated like accumulating funds in terms of taxation – distributions are taxed as dividend income despite not being paid out. Could get very complex if held in a taxable account…
I’ve found the source that gave me that impression:
“How to chose the right ETF”
http://www.ft.com/cms/s/0/bb99adf4-ea02-11e2-913c-00144feabdc0.html#ixzz2aNqDg0MM
I’ll paste the relevant extract as a small clipping is fair use:
“ETFs may be “capitalising” (meaning the dividends are reinvested) or “distributing” (meaning they are paid out). Many higher-rate taxpayers prefer capitalising ETFs as all gains are taxed as capital, whereas the dividends from distributing ETFs are treated as income.”
However, there is a comment by a reader saying this isn’t the case. Now, normally I’d trust an FT journalist to have got their facts right, but as Vanguardfan says, it doesn’t really fit in with the treatment of OEICs.
Anyway, it will be a _very_ long time before this sort of thing affects me so I’ll leave it to someone else…
@greg – I remember it was a discussion on motley fool. I’m afraid I think the FT journalist is wrong, although probably not alone in this – I’ve had telephone service staff from brokers tell me that distributions within accumulating funds (Oeics) are not taxable as dividends…
The ishares website provides ‘reportable income’ statements which can be used to calculate the distributions in capitalising ETFs which I am pretty confident are taxable as dividend income.
http://uk.ishares.com/en/rc/about/tax
@vanguarddfan, @greg
If your a basic rate taxpayer you won’t need to pay any tax as I understand, but I believe you still have to declare it. I’m not sure how, because if your a basic rate taxpayer you don’t normally complete a tax return. If your other half is a basic rate taxpayer (and trustworthy !), it does simplify matters.
I hold I shares global linked Gov Bond ETF and I shares Global Gov bond ETF. Not sure why, but the linked bonds income is accumulating and the standard bonds income is distributing and i’m getting hit by extra trading/reinvestment costs. Searching for Accumulating Global Gov bond funds right now.
@ Alex – thanks for sharing. I’ve not seen any articles on what happens when an ETF delists and it’s not happened to me yet.
@ Ric – yes, I’d be interested to know that too. There seems to be a massive range. There are clearly some very wealthy individuals commenting on Monevator but then I’ve also read comments from readers who say the notional £250 a month drip-feed into the Slow & Steady portfolio is too rich for their blood.
@ AJ & Jon – I just roll divis that accumulate in my TD account into my next regular purchase, avoiding any extra reinvestment fee. Can you not do this at your brokers?
As an aside, HL charge for holding ETFs in your account, so best avoided anyway.
@ Malfesto – thanks for the link. Interesting discussion. Though important not to let the tail wag the dog.
@ Greg – some foreign-distributed ETFs can be held in ISAs (i.e. ETFs not meant for UK investors), but you’re right most can not. There’s a good piece here on the subject:
http://the-international-investor.com/investment-faq/funds-etfs-eligible-held-isa
@ Steve B – thanks for the link. A good resource, although mind out they’re missing Vanguard, State Street and some of the smaller players.
Capitalising equity ETFs are taxable as dividend income.
@ The Accumulator – Please may I explain about Vanguard, State Street and the smaller players, which you wrote are missing from whichetf’s table? Vanguard’s nine ETF are in it; but because the FCA forbids all issuers from giving performance info until an ETP is a year old, I can’t yet show more data. State Street also is in the table, but listed under its ETP name of SPDR. At the next revision I will add the name State Street, to avoid any confusion. The table lists all the ‘long-only’ ETF, of which there are currently 438. I have filleted out 1,000+ funds; any that are either short, leveraged or institutional. I have listed commodity-basket ETC, but cut out the individual ones (heating oil anyone?). I left in gold and copper, because they remain valid for the retail market. Like you, I want everyone to have easy access to good-value investments, so the table is free-of-charge to use. Thank you for letting me respond.
Great article, gives a good comparison to a OEIC portfolio (which I have, although I can’t say I haven’t been tempted by the siren song of the ETF).
Just out of curiosity, why is Charles-Stanley Direct considered a good option only up until £20k? Do they start charging more once you hold more than this?
I note that the Vanguard ETFs offered by Sippdeal on their regular investment service are the $ designated versions i.e. VWRD and VUSD – should this be a consideration or concern for prospective purchasers?
I think that it is worth mentioning that the dealing fee associated with ETFs is typically more than offset by the limit order feature, which you do not get with regular funds. Barring scenarios where you absolutely have to buy or sell at this very moment, the value of a reasonably sized ETF deal will usually be subject to short-term (a few days) fluctuations exceeding the dealing fee. As a committed passive investor, I would not attempt to time the market in medium term, but the kind of automated short-term timing offered by limit orders is not against this principle. I never get overly ambitious when setting the limit – just to recover the dealing fee :-). For more adventurous investors, there are also stop and trailing stop orders, which are offered by many trading platforms and can be useful for investing in ETFs – again, not available for regular funds.
@ Dexter – I would have recognised SPDR but they didn’t show up when I looked the other night. However they do now along with Vanguard and the other smaller players I mentioned in my comment above. It looks pretty amaingly comprehensive now. I must have previously left one of the other filters on which cut down the list. Apologies! Will have a good play with the table when I can and send you some feedback. Thank you for putting so much effort into this resource. Looks like you’ve done a grand job.
@ Westy – no, I wouldn’t worry about it. The £ versions are just the $ versions that are currency exchanged for you. In terms of your returns it makes no real difference at all.
@ Tudou – it’s because once you go over the £50 mark with Charles Stanley, you may well be better off with a flat-rate broker like Alliance Trust. Alliance Trust charge £48 no matter what size your portfolio.
On the tax question re income tax liability of “capitalising” etf, the actual situation will depend on whether they are physical or synthetic. In all cases, assuming the offshore fund has reporting status, you must declare the excess reportable income which is taxed as income or dividends received six months after reporting period.
If the fund is physical the income will be the actual dividends received less non-reclaimable withholding tax. The outcome is thus the same except for timing as an accumulating fund.
If the fund is synthetic then the swap counterparty is tracking a total return index. The only income received in the fund may be some interest on cash – dividends on collateral are pledged to the counterparty. The effect is that the notional dividends capitalise free of income tax. Though this only helps if you are a higher rate tax payer.
To confuse things further, all synthetic funds track NET versions of total return indexes from MSCI, STOXx etc. These assume a worst case that all withholding tax is paid and not reclaimable ie 30% on US equities. So less dividend is capitalised than in a physical fund.
Pay your money take your choice….
A synthetic or physical ETF structure makes no difference to an investor’s tax liability.
@Accumulator. Correct. You always are taxed on the excess reportable income
My point is that a capitalising synthetic one will have very little as a it tracks a net tr index whereas an accumulating physical will have a lot – just like an accumulating oeic. That said afaik all physical etf tend to distribute.
Physical ETFs can track net TR indices too.
Just a note for anyone looking to do this with TD Direct:
The ability to add ETFs as regular investment choices is dependent on the ETF being UK-listed and denominated in £GBP. It also cannot have a dual listing on another non-£GBP market.
VWRL has the equivalent VWRD in $USD and is therefore not allowed as a regular investment choice.
Researching an ETF the other evening I noticed that all the trades for that day (6 or 7 in total) were “buy”.
I had assumed that the same number of shares had to be sold as bought. Can anyone explain this for me? Cheers.
An ETF is an open-ended vehicle – in other words, shares can be created to meet demand, so no need for equalisation between purchases and sales.
I’ve just spent a couple of hours trying to get to the bottom of the question of UK income tax on “capitalising” ETF’s. This thread came up high in my seaches but some of the information in it is wrong or out-dated, so I thought I’d add my two pennorth for posterity.
Here are my conclusions.
If you are a UK tax-payer, you cannot avoid income tax by investing in a capitalising ETF. If the ETF does not have “reporting status”, you will be liable to income tax even on your capital gains. To obtain and keep “reporting” status, the ETF basicly has to report for each accounting period the income which accrues to holders, whether it is paid out to them as dividends or not. So you will end up paying income tax on the income element of the investment return. Which I guess is the result you would expect. Shame on the FT for its misleading article!
@Andy — Have you seen this article?
http://monevator.com/excess-reportable-income/
A couple of other points that I have just came across is that ETFs can change what they track, but still remain under the same ticker, “Past Performance Is No Guarantee of Future Results” indeed, http://www.etf.com/sections/features-and-news/when-etf-changes-its-exposure?nopaging=1
There is also the point of who owns the fund, rather than who advertises it http://www.etf.com/sections/blog/who-actually-owns-your-etf?nopaging=1