Evaluating the Best DCA Investment for Our Son: ETF vs. Investment Trust in Ireland

[fredmach]

Hey everyone,

My wife and I have been delving into the best possible Dollar-Cost Averaging (DCA) investment strategy for our 6-year-old son, using the €3,000 a year tax-free gift allowance we each can make to him. We've compared two investment options in Ireland over a 30-year period, starting with an initial €6,000 investment and adding €500 monthly using a Davy Minor Account to purchase both options. Cost of purchase has not been taken into account. I've laid out all our findings in this spreadsheet for those who love diving into the data you can find it here, please proof the maths: Google Sheets Spreadsheet.

Here's a summary of what we found:

Investment Options:

1. ETF Investment: VWCE

• Return: 8% per annum
• Yield: 0%
• Charges: 0.22% per year
• Tax: 41% on gains, with DD TAX every 8 years subtracted from the investment.

1. Investment Trust: FCIT

• Return: 6.5% per annum
• Yield: 1.5% (reinvested after 52% tax)
• Charges: 0.54% per year
• Tax: 33% capital gains tax on exit after 30 years

Methodology:

• We meticulously calculated monthly growth, charges, and taxes for each option.
• For the ETF, we included the 41% tax at 8-year intervals and an additional exit tax at the 30-year mark.
• For the Investment Trust, we factored in the yield after a 52% tax deduction, reinvesting it, and applied a 33% capital gains tax upon exit.

Findings:

• ETF Investment: Considering the DD Tax every 8 years and exit tax at 30 years, the final take-home amount is approximately €299,321
• Investment Trust: After accounting for the 33% capital gains tax on exit, the final take-home amount is about €400,917

Conclusion: Through our analysis, the Investment Trust emerges as the superior option for our son's long-term investment, offering a higher final take-home amount over 30 years despite its lower return rate and higher charges. This advantage primarily stems from the tax benefits associated with yield reinvestment and the comparatively favorable capital gains tax versus the ETF's deemed disposal and exit taxes.

We're eager to hear your thoughts or any advice on optimizing these investments!

I hope someone can help proof these figures to confirm my findings.

UPDATE:

Upon review of the figures with another member who highlighted an error that had been made in the Deemed Disposal calculations, the results and spreadsheet have been amended.

The disparity in performance between the ETF investment option and the Trust investment is huge. This analysis emphasizes how the imposition of the crippling Deemed Disposal tax can disrupt the compounding interest cycle, leading to detrimental outcomes.

A key shortfall among contemporary humans lies in their under-appreciation of the exponential function, especially regarding its critical role in compound interest.

For an easy lesson in helping yourself to understand the exponential function, here is a video that will possible change your world view forever:

Exponential Growth Arithmetic, Population and Energy, Dr. Albert A. Bartlett

UPDATE 11/03/2024:

The complexity of the calculations for calculating the growth of an ETF investment with DCA style of investing was seriously underestimated and upon review of my calculations, CoronetCapulet pointed out the error in my ways, so i went back to the drawing board to recalculate and track the lifecycle of each of the 360 investments over a 30 year period, calculating fees, growth and DD for each individual investment along the way to arrive at an accurate figure. This time we took a straightforward

The methods used were:

To provide a comprehensive breakdown of the steps and calculations we performed to arrive at the final figure of approximately 430,091.74 quid, I'll detail each step, including all considerations about fees, the "Deemed Disposal Tax" at the 8-year intervals, and the "Exit Tax" at the end:

• ETF Investment:
  • Started with the premise of investing 500 quid monthly into a fund with an 8% annual growth rate, over a period of 30 years.
  • An annual fee of 0.22% was deducted from the total fund value at the end of each year.
• Deemed Disposal Tax Calculation:
  • At the end of every 8th year, for each individual 500 quid investment, a "Deemed Disposal Tax" of 41% was applied to the gains made by that specific investment up to that point.
  • This tax simulates a disposal and repurchase of the investment, taxing the gains without actual liquidation.
  • The tax was applied individually to each investment, taking into account its specific growth up to the 8th, 16th, and 24th years from its start date.
• Investment Growth Calculation:
  • Each 500 quid investment was tracked individually over the 30-year period, calculating monthly growth based on the annual rate, adjusted for the impact of fees and taxes.
  • The growth calculation accounted for the compounding effect, with the fund's value increasing each month due to both the addition of new investments and the growth of existing investments.
• Exit Tax Calculation at the 30-Year Mark:
  • At the end of the 30-year period, an "Exit Tax" of 41% was applied to the gains that had accumulated since the last "Deemed Disposal Tax" event for each investment.
  • This tax was calculated by determining the gains for each investment from its last tax event (or from its start, if no tax had been applied) to the end of the 30 years.
  • The calculation ensured that gains were not taxed twice, applying the "Exit Tax" only on gains that had not previously been subject to the "Deemed Disposal Tax."
• Final Calculation of Take-Home Amount:
  • The final fund value was determined by summing the post-tax values of all individual investments at the end of the 30 years.
  • From this total, the "Exit Tax" due on accumulated gains since the last "Deemed Disposal Tax" event was deducted, resulting in the final take-home amount of approximately €430,091.74
• Considerations:
  • The calculation model was refined through discussions to accurately account for the timing and impact of taxes, fees, and compound growth on each investment.
  • The approach reflected a realistic and nuanced understanding of how investments grow over time and how different tax events affect the overall returns.

VS.

• Investment Fund Investment:
  • Started with an initial investment of €500.
  • Planned to invest €500 monthly for 30 years.
• Growth and Yield Parameters:
  • The trust grows at an annual rate of 6.5%.
  • It yields dividends at an annual rate of 1.5%.
• Taxes and Fees:
  • Dividends are taxed at a rate of 52% before being reinvested.
  • The investment's balance is subject to management fees of 0.54% annually.
  • A capital gains tax of 33% is applied on the gains at the end of the 30-year period.
• Monthly Calculations:
  • Each month, the investment grows based on the monthly equivalent of the annual growth rate.
  • Dividends are calculated monthly, taxed, and the remainder is reinvested into the trust.
  • Management fees are deducted from the total investment at the end of each year.
• Capital Gains Tax Calculation:
  • At the end of 30 years, the total gains are calculated by subtracting the total contributions from the final investment value before taxes.
  • Capital gains tax is then calculated on these gains and deducted to find the final value after tax.
• Final Figures:
  • The investment's final value before tax was approximately €553,466.89.
  • After applying capital gains tax, the final amount available was approximately €430,222.81

This detailed breakdown encapsulates the methodology and considerations that led to the final figure, ready for peer review

See link here to the new spreadsheet: Click Here

Quite a surprise if the new figures are correct, as there doesent appear to be any difference between either option

 

[lilacrose]

@fredmach Just had a son myself and was literally going to do these calculations myself on Saturday, thanks for putting in the leg work for us

 

[jakebakes]

@fredmach I've been down the same road. Ultimately I went with ETF though. Yes it's expensive but the investment trusts people speak of here like Scottish Mortgage and JAMF - you should really look into them. Most of them are a bit of a shitshow. Their strategy is risky, unclear, full of weird investments, they don't beat the market over time, incentivises fund managers to do stupid stuff and in my view, probably not worth it. People often put Berkshire Hathaway in the same basket, but that's 40 percent just in Apple. Which ones are you thinking?

 

[hamiido]

@jakebakes 94% of JAM is in what I would say are not weird investments. How are you assessing it?

 

[willumg]

@jakebakes Scottish Mortgage in particular doesn't even remotely follow its benchmark. It's way too volatile to recommend as an alternative to an ETF.

https://g.co/finance/SMT:LON?window=5Y&comparison=LON:VWRP

 

[pastorjustin]

@jakebakes Can you share more details on the choice you made. Which ETFs you are invested in now? Also, what would have been the consequences if you invested in an Investment Trust in money terms. Many thanks!

 

[harttysoul]

@jakebakes What about JGGI? I’ve been trying to get one set to in my daughters name and keep trying to contact Zurich to do it but never get a call back or correct info by email. It’s like they don’t want my business(I actually expect this is the case).

 

[jakebakes]

@harttysoul Doing anything through Zurich seems like such a penalty cost wise.

 

[harttysoul]

@jakebakes Any suggestions for an alternative?

 

[fredmach]

@harttysoul Davy Minor Account

 

[hamiido]

@harttysoul JGgI is more expensive fees than JAM

 

[destony]

@fredmach Really interesting post. Your methodology for calculating net returns looks correct. Similar to previous comparisons between ETFs and ITs it seems that the IT breaks away from ETF returns significantly after 15-20ish years.

In a shorter period (8-15 years) I personally think the wider choice and the less perceived risk of ETFs without leverage or murky private equity investing makes ETFs a superior choice.

 

[willumg]

@fredmach You need to deduct 0.5% stamp duty from the initial and monthly IT investments

 

[fredmach]

@willumg Ill get the edits done tomorrow, thanks for this. I have revised the numbers following other observations and the difference in the 2 investment options is staggering.

 

[blesshakinah]

@willumg Does the broker take this away automatically or is the onus on the investor to declare and pay it to the UK?

 

[khadie]

@blesshakinah Stamp duty is take automatically with the brokers Davys, Degiro etc

 

[blesshakinah]

@khadie Thanks!