Money tree

Disclaimer

This page does not provide professional advice, the information on this page reflects personal opinions and not investment advice. You can lose (part of) your investment.

Plant a Money Tree

We grow a money tree. It will stay, grow, and produce money throughout our life.

Sounds too good to be true?

Our tree consists of investments in the widest possible proportion of internationally accessible listed stocks (in relation to the market-capitalization). To strengthen the tree, we’ve added government bonds hedged to our local currency (€). And all at the lowest possible cost.

We first structured our relationship finances, and analyzed our current and future expenses to determine how much we can set aside monthly. We only invest money that we won’t need coming 10 years, even if our situation would change unexpectedly. This strategy works when you are slowly saving, or when you have received a windfall.

We harvest a maximum of 3% of the invested value, OR 3% of the total portfolio value of our tree per year. So when we have invested €50.000 in the tree, we harvest a maximum of €125 per month (regardless of the state of the stock market), or more when we need the money and the portfolio value is higher.

If we manage to invest €1.000.000, we would get a €30.000 (gross) yearly income from the “tree”.

Basic steps

  1. Sort out your relationship finances
  2. Open a “self-investment” account with a broker or your bank
  3. Start building the suggested portfolio
  4. If available, add funds monthly in-line with the chosen asset allocation
  5. Don’t actively rebalance already invested funds
  6. Harvest your tree yearly (when needed)

Why do we share this information? We wish for everyone to have an option to grow such a tree, big or small. This website does not generate any income. There are no advertisements and / or affiliate links.


Portfolio

Indexes benchmark

We’re not trying to pick any good stock, we simply invest in “the world”. MSCI ACWI IMI tracks the entire investable stock market (developed and emerging countries) and includes large/medium/small companies that are stock listed.


Portfolio NL

If you are based in The Netherlands, some funds can reduce dividend tax leakage because of a fairly unique tax treaty with the USA. Therefore I would go for:

  • 55% – Northern Trust World Custom ESG Equity Indexfonds (NL0011225305)
  • 8% – Northern Trust Emerging Markets Custom ESG Equity Index (NL0011515424)
  • 7% – Northern Trust World Small Cap ESG Low Carbon indexfonds (NL0013552078)
  • 30% Dutch government guaranteed bank saving

As long as your fixed income allocation remains within the limit of the “depositogarantiestelsel”, in current economic climate I would NOT go for DBZB and instead simply put that money on a (Dutch government protected) savings account.

The main advantage of using Northern Trust Dutch domiciled funds is tax benefits, effectively lowering internal costs.

Portfolio EU

Portfolio ignoring broker cost for non-Dutch:

  • 70% – Vanguard FTSE All-World ETF (VWCE.DE, IE00BK5BQT80, EUR, accumulating)
  • 30% – Xtrackers II Global Government Bond UCITS ETF 1C – EUR Hedged (DBZB.DE, LU0378818131, EUR, accumulating)

Portfolio USA

If you are based in the USA, you can better use Vanguard Total World Stock ETF (VT) instead of VWCE, since it includes small cap stocks.


Asset allocation

The optimal allocation of stocks / bonds depends on your willingness to risk and the period for which you can put the money away.

When investing the costs, expected return, and volatility are relevant. More return means more volatility. Stocks have a high return and high volatility. Government bonds have a low return and low volatility. There is no high return with low volatility, because if that would exist everyone would invest in it (reducing the return).

For younger investors (<40 years) with a long investing horizon (20+ years), a good ratio is 70% stocks and 30% bonds. That seems optimal for the risk / return ratio, and optimal for a 3% annual withdrawal rate (see safe withdrawal rate). Always keep a healthy amount of “emergency money” in cash (e.g. 6 months worth of expenses).

A portfolio of 100% stocks is the most profitable, but also has the highest volatility. By investing part in bonds, you significantly reduce volatility, the return you yield for it is often worth it for peace of mind.


Stocks

Unfortunately there is no “holy grail” ETF available to Europeans yet to cover the investable global stock market. For people with access to US listed ETFs, Vanguard VT is closest to covering the world at a low expense.

If you cannot access Vanguard VT, or your country has no special tax-treaty avoiding double taxation with the US, alternatives to look at would be VWRL (developed+emerging distributing), VWCE (developed+emerging accumulating), IWDA (developed accumulating), AVIAW (developed distributing ESG with tax advantage for the Dutch).

Let’s take a closer look at ACTIAM Responsible Index World Equity Fund (AVIAW). Theoretically, AVIAW should yield ~0.18% extra return to Dutch people than an ETF with Irish domicile because in the Netherlands the US withholding tax can be brought to 0% by the fund via the US treaty and you yourself can reduce the 15% withheld tax by the fund with the the tax authorities can set off. Note AVIAW recently started excluding a significant number of stocks based on more strict ESG criteria and hence may not track the global market accurately anymore. Northern Trust FGR funds provide a similar Dutch tax advantage with less exclusions (at a higher TER though).

IWDA on the other hand has outperformed the index by an average of 0.113% over the past 3 years (2016-2018). AVIAW performed an average of 0.425% better over the same period. On average, AVIAW performs 0.313% better than IWDA per year. The difference in TER explains 0.05% of that, so the actual better performance is 0.263%. This can be partly attributed to the dividend benefit, partly to the ESG overlay. For 2017, Actiam indicates in the annual report that a 0.42% dividend benefit has been achieved and that the ESG overlay has cost 0.10% in basis points. The dividend benefit is relative to the index, IWDA also has a dividend benefit so it is difficult to compare. In 2017 AVIAW performed 0.12% better than IWDA. If you take the 0.05% TER off, you get 0.05% better performance. If you add the negative effect of 0.10% due to the ESG overlay, you get a better performance of 0.17% for that year. So the sum seems to add up!

Please note, outside of the ESG exclusions, AVIAW lacks 11 holdings in Israel because that country is not geographically included in their regional sub-funds. Israel is only 0.19% of the MSCI World Index market cap (2018) so that effect can be considered negligible.

VWRL/VWCE include emerging markets, and although there is no tax advantage for Dutch people .. and it is not the cheapest (compared to e.g. IWDA) .. the low cost and wide coverage make it the best choice for us long term. We favor VWCE not to have to deal with US$ dividends (since they are automatically reinvested).


Bonds

Bonds are fundamentally different from shares because the yield is known in advance (the so-called yield to maturity (YTM)). Corporate bonds have a higher risk to default than government bonds, and hence often have a higher yield. In the current market, the YTM is almost the same as government bonds though. This is due to the various government buying programs. As a result, the extra risk is now completely out of proportion to the extra return.

The bond duration partly determines the yield (longer duration typically means higher yield), but also how sensitive the price will be to changes in interest rates. From a duration of ~8 years, the curve flattens and you get relatively little extra return per extra year of commitment. With the extremely low interest rates at the moment, you could opt for a shorter duration, but then you will start market times again. Everyone expects interest rates to rise quickly, but countries like Japan have had low interest rates for decades. So you never know how it goes, that’s why it’s good to have international exposure.

Corporate bonds are NOT a good hedge to remove volatility, because they move significantly with shares and certainly also in the event of a crash. If you want more return, you better allocate a larger percentage of shares. If you want less volatility, you do that with government bonds. Corporate bonds are sort of in between, and hence can be better avoided.


Microcredits

You could allocate 5% of the fixed income to microcredits. The Triodos Fair Share Fund (TFSF , NL0013087968, distributing) may be a good option. Microcredits, like bonds, have a negative correlation with stocks.


Brokers

Your bank may offer broker services, or you can use a generic broker in Netherlands. We are using ABN Amro currently because they are one of the banks allowing access to the best available portfolio for Dutch citizens today.

For generic brokers Binck would seem one of the more reliable ones, and they allow to optionally generate additional income from securities lending.

When you consider DeGiro go for custody (there is nothing wrong with lending, however they are not transparent about what has been lent and they don’t share the revenue). Also note the AFM recently released a report about violations from DeGiro putting their customers’ investments at risk (even with custody), they are working on resolving that (and were recently bought by Flatex which should further help in that process).

If you choose Lynx, keep in mind that you can not just switch to their parent company Interactive Brokers, which will become cheaper with larger investments. Also the funds/stock are technically held in the USA so the supervision from AFM will be minimal.

That said, the larger banks are dropping their fees and are catching up. This may offer access to more low cost (normally institutional) funds especially when you are just starting to invest.


Costs

When assessing the best portfolio, it is important to look at the costs, including: the Total Expense Ratio (TER), any lending income, whether there is a dividend leak advantage, the effect of any taxes, and the actual return.

Broker costs are relevant, however they should not drive the choice of portfolio as for a long term strategy it is better to adjust the broker to the portfolio and not the other way around.

Beware of “bargain brokers”, which hope to grow quickly with a temporary lure. Investments are long term.


Domicile and dividend leak

The domicile of an ETF/fund determines which tax regime applies to that ETf/fund. This then concerns tax that is levied on dividends to the fund and any tax that is levied on the distribution of dividends. Ireland and Luxembourg for example do not have to charge dividend tax on distribution, and hence provide a popular domicile.

The ETF/fund must pay tax on the dividends received, depending on the domicile there may be a treaty that reduces this payment. Ireland, for example, has a treaty with the US, just like the Netherlands, whereby the US dividends tax impact decreases from 30% to 15%. Ireland has no withholding tax when it pays dividends, so the total “dividend leak” for the US is 15%. Luxembourg does not have this treaty, so the tax remains 30% of the dividend. If the domicile is the Netherlands, the US tax will be reduced to 15%, just like in Ireland. The Dutch ETF/fund shifts the withholding tax of 15% on the payment of dividend to the holder, which you can set off against your income, so that you effectively pay 0% USA dividend tax as Dutch citizen.

Ireland and Luxembourg are easy to compare because UBS offers the MSCI USA index from both Ireland and Luxembourg. Assuming a 2% dividend, Ireland should outperform Luxembourg for USA stocks with: 15% * 2% = 0.3%. In 2018, the Irish variant outperformed 0.22%, 0.30% in 2017, 0.34% in 2016, 0.24% in 2015. The 0.3% therefore indeed appears to be correct. The difference per year can possibly be explained by the fact that it takes a while before the tax is indeed received back.

If you compare Ireland with the Netherlands as domicile, there should be no difference in terms of US yield (after all, the treaty reduces the tax from 30% to 15% for both domiciles). However, there is an EXTRA advantage of 0.3% on the USA portion for the Dutch domicile, because you can get it back through the tax authorities. If you assume 60% USA in the World index, the Dutch advantage is therefore 0.18% compared to an Irish domicile (and 2 * 0.18% = 0.36% compared to a Luxembourg domicile).


Dividends

When a stock or ETF pays dividends, the price falls proportionately. The amount of the dividend therefore says nothing about the long-term appreciation. Psychologically, such a dividend often feels good, but it has no real added value. In a crash, the so-called high-dividend shares will also fall faster because it is more difficult to continue to pay out the promised dividend in such a situation. The only advantage is that without this knowledge you will assume that they will continue to yield a fixed return (and you will ignore the loss of value), which will make you less likely to panic.

It is best to invest dividend paid immediately (or at your next investment). This way you get value on value increase. When reinvesting, you need to see if the investment goes to stocks or bonds to keep your asset allocation intact. With accumulating stocks/bonds, there is no need to manually handle dividends.


Market capitalization

The great thing about market cap as an underlying ratio is that the balance automatically continues to add up. For example, if the emerging markets grow compared to the developed market, the underlying ETF will grow exactly in proportion. So when you stop investing, you do not have to actively rebalance the underlying shares, that happens automatically. Only the shares / bonds ratio will diverge.

When you combine accumulating ETFs, the different dividend percentage will cause deviation from the market cap, as paying dividends lowers the market cap. Because the dividend percentage will differ per ETF, the ETF that receives more dividend will increase slightly more than the market cap due to automatic reinvestment.


Rebalancing

When you invest periodically (for example, wages or dividends), it is wise to keep your portfolio in balance in line with your chosen risk profile.

Please note, the frequently mentioned “rebalancing premium” (buying low / selling high) actually does not exist (figure 8). Return is the highest on shares, but then you also have the highest volatility. Rebalancing from stocks to bonds feels like taking a profit, however, you move your money from higher returns with higher volatility (shares) to lower returns with lower volatility (bonds). In a stock market crash, rebalancing may even lower the low point, as the money you move from bonds to shares during the crash (to keep the asset allocation intact) will fall further as long as the stock market goes down. In such a case, it is better to do nothing at all for your own mood, until everything has recovered (after a few years).

By depositing only new investable money (dividend or external income) to asset allocation, you save transaction costs. If you want to take a more defensive approach, you can annually choose to only rebalance from shares to bonds (and not the other way around). This will further reduce volatility, but also the long-term return.


Safe withdrawal

In the withdrawal (or harvesting) phase, you’ll generally want to minimize the money you extract from your investments just to be on the safe side. Based on historical data, it should be fairly safe to harvest a (pre-tax) maximum of 3% of the invested value, OR 3% of the total portfolio value of your “tree” per year.

During the withdrawal-only phase (when you stop investing money) it is advisable to rebalance to bonds on a fixed date, for example with a deviation >5%. Although this lowers the long-term return, it reduces the chance that you will run out of money earlier because of the lower volatility (in a bad market) when you withdraw 3% per year.


Windfall

If you have a lot of savings, won the lottery, sold your bitcoins (at profit), or received an inheritance, it feels very risky to invest your money at once. After all, someone predicts an upcoming stock market crash every day.

However, that risk is already included in the price, and if you do not believe in market timing, you should invest the money at once. Only (important) sidenote here is that there is NO RUSH! Feel free to hold off investing for a year to decide what you are most comfortable with, such delay won’t (statistically) hurt your long term return.

Remember that on average the stock market is usually at its highest point ever (after all, the stock market rises on average). If you do not dare to make a direct investment, spread it over a maximum of 6 months. Vanguard has published a good study of such a lump sum investment.

Finally, whatever happens, stick to your strategy. There will always be large fluctuations, the emotional long-term risk of loss is greatest.


Currency hedging

Interest rates and inflation have a significant impact on both bonds and currencies. Therefore these are highly interlinked. Currencies fluctuate, in the long term those fluctuations should average out. Currency fluctuations are directly linked to the relevant risk of the underlying assets (countries) compared to the rest of the world.

The main reason to hold government bonds is to reduce volatility. When you currency hedge your bonds, you further reduce the volatility in your home currency. Hedging itself is cheap, however there is no “free money” and the YTM is adjusted to the risk-spread compared to your currency. So if the YTM of global bonds shows 0,5%, and your currency has a risk-free (government) interest of 0%, the hedging will effectively cost you 0,5% for risk-free bonds (and your return will be 0%, or less considering TER etc). This applies the other way around as well. Not all bonds in DBZB are issued from risk-free countries of course, so you still collect that risk premium.

For stocks it doesn’t make sense to hedge the currency, as the goal is to increase the value and not reduce the volatility.

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