Without a tax-advantaged account, do you invest in ETFs or mutual funds (via Vanguard)?

[kevineto123]

Background:

•26 year old American with a wife and 1 child

•currently working at a high school in the US making $49,000

•I’ll start teaching at an international high school (who knows where) next year and make a career out of it; salary could be anywhere between $20,000 and $50,000

Since I won’t have access to an IRA or 401K because of the FEIE, I want to start an investment portfolio of index funds through Vanguard. But I don’t know if I should be buying into the mutual funds or ETFs.

This will be a retirement account (i.e., put money in, don’t touch it for 35 years), so I don’t need to do any day trading, like ETFs allow for, but the ETFs on Vanguard have a slightly cheaper expense ratio, but mutual funds allow for partial shares, so I don’t have to wait to purchase the funds until I have the specific dollar amount, and while I’m waiting for my next paycheck to invest in the ETF my money isn’t growing; any amount of money can be invested in a mutual fund. Both are passive though, and that’s nice. I don’t want an actively managed fund.

I’m worried about taxes on the dividends and capital gains—mainly because I don’t really understand them. So I want to start investing in the right way, from the beginning. Thoughts?

 

[stephendisraeli]

@kevineto123

Thoughts?

First, once you find out where "who knows where" is, figure out whether it is better to claim the FEIE or the FTC. In a high-tax country, claiming the FTC may be advantageous.

 

[kevineto123]

@stephendisraeli Thank you! Unfortunately, I haven’t come across the term “FTC” in my reading... Still new to this—as you can tell. So now I have something else to read! Thanks

 

[stephendisraeli]

@kevineto123 FTC stands for foreign tax credit. It allows the taxpayer to use income taxes paid or accrued to the country of residence as a credit against their US tax liability.

This is a bit more involved to calculate, but it allows contributions to retirement plans.

Also, do check the tax treaty between the US and the country of residence. Much of the treaty will be irrelevant due to savings clauses/treaty overrides, but some retirement/pension plans are usually covered. If they are not, this could mean that the country of residence may tax gains in such plans as they occur and not allow tax deferral.

 

[mihailolt]

@kevineto123 Foreign Tax Credit. If the numbers work out (which is usually the case in high-tax countries) it can be more flexible than the Foreign Earned Income Exclusion. But it's a little more calculation at tax time.

 

[jacob_]

@kevineto123 In my opinion Vanguard ETFs are an excellent choice. Regarding dividend taxation, you need to check double taxation agreement between US and the country you are living in. There may be some tax, but this should also apply to mutual funds.

The most important thing is that you should make sure that you invest in US-domiciled funds (regardless of mutual funds or ETFs) due to the PFIC regulation from the US. This is sometimes difficult from abroad, because for example in Europe regulation forbids brokers to sell US products (as also mentioned on the link above). To avoid this, it is best to have a US based brokerage account. I personally recommend Interactive Brokers Lite, which is mostly free like Robinhood (no monthly fee, no trading fees on US exchanges etc.), but allows you to deposit money from foreign accounts (useful if you are getting paid in local currency where you live). It even allows you to transfer money internationally for much lower fees than Transferwise/Wise etc. And in regards to your statement about fractional shares: You should also be able to purchase fractional shares of Vanguard ETFs in Interactive Brokers Lite.

Now regarding the ETF choices themselves. I personally like the following products:

• VT: Vanguard Total World Stock ETF (VT)
  
  Covers the worldwide stock markets with very low fees. If you want to keep things simple, I don't think you would make a mistake with ONLY investing there.
• VTI: Vanguard Total Stock Market ETF (VTI)
  
  Covers US markets in a broad way (more than 3000 stocks).
• VEA: Vanguard FTSE Developed Markets ETF (VEA)
  
  Covers developed markets outside of the US (mostly Europe and Japan).
• VWO: Vanguard's FTSE Emerging Markets ETF (VWO)
  
  Covers emerging markets (like China, Russia, Brazil etc.)
• QQQ: Invesco QQQ Trust Series 1 (QQQ)
  
  Tracks the Nasdaq index on technology - if you believe that tech companies (like Google, Facebook etc.) will continue to grow faster than what the market expects, this could be a bet, but I would advise against large sector bets (so maximally 5-10% of a portfolio and totally not necessary).

Of course, I'm not a financial advisor, but I hope this information helps. IMHO: If you don't enjoy spending time on investing, just invest monthly a fixed amount in VT. This should be solid longterm strategy and if somebody claims to know better or that you can get better returns somewhere else (crypto, individual bets, growth companies etc.), they will likely conceal some risk.

 

[kevineto123]

@jacob_ Thank you so much for such a detailed reply. I love it!

 

[khaeous999]

@jacob_ Thanks for the detailed answer but are you sure this is possible through IBKR? I'm thinking about moving to Europe as a US citizen but when I click this link below and set Netherlands for example as the region it will only show me Ireland/UK domiciled vanguard funds. Granted, I don't have an account with them and I don't how the actual mutual fund/etf options look like once you have an account but I just wanted to ask. https://www.interactivebrokers.com/en/index.php?f=46321#/