The Smartest Way to Invest in ETFs in Germany

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Dr. Christian Mulder

Mar 16, 2022
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Most people do not realise that trading or just rebalancing their ETF portfolio can be very costly in terms of long-term return. Maybe your portfolio is small now, but over time it will grow, and the amounts you lose will become very sizable. Therefore we recommend a Pension Insurance product that helps to minimize your capital gains taxes and grow your portfolio grow faster over time. The following calculator can help you understand whether investing in ETFs through such a pension product makes sense for you.

Let’s calculate whether you can save with a Pension Product

The key input items are your investment portfolio value of
10.000 €
and how much you would invest into your portfolio each year on average:
0 €
. Let's assume your expected return is
7 %
(investing in stocks can be expected to return 6-8% in the very long run, over 30 years). And that you rebalance
15 %
of your portfolio on average each year. Of the capital gains tax-free amount of 800 Euro, you use about
400 €
euro per year. Lastly, what is your age:
26 years

The results of our comparison

With these inputs your capital gains taxes reduce your return by about 1,150 % per year. Over 40 years this will cost you 26.396,08 €.

The more you rebalance your portfolio the higher your losses because of taxes. Keep in mind that rebalancing standard portfolios typically means buying or selling at least 8-10% per year. Actively managed portfolios have a much higher turnover. 

The solution, in Germany, for you is a low-cost tax wrapper (a Private Rentenversicherung, or PRV).  This tax-efficient solution saves you annually in terms of return 0,2200 %.  Overall in 40 years your potential gain (after tax) would be 102.187,36 €. You can go to your inputs above and simulate the impact of a high turnover rate. Keep in mind that in the future you may need to rebalance your portfolio pretty fundamentally (like when interest rates increase).  

Created with Highcharts 9.3.2ETFPRV0510152025303540€0€25,000€50,000€75,000€100,000€125,000€150,000

So what is the secret here? There are two reasons:

  1. You pay capital gain tax only once if you use a PRV tax wrapper namely when you take out the money.  If you would instead have an ETF portfolio with a broker, you pay tax every year on the gains beyond the threshold. The big drawback is that the tax you paid is no longer invested and no longer earns money for you.

  2. You can benefit from paying just half the capital gains tax (26,375% vs 13,1875%) if you take the money out after age 62 in a lump sum. 

However, it is absolutely essential that you choose low-cost private pension insurance to take advantage of the tax wrapper. Most products in the market have big costs. Therefore we have reviewed all insurance companies' costs, built a cost calculator to assess all the different costs, to find the lowest cost solutions! Cost ranges from about 0,5% per year to over 4%! The above example uses our lowest cost product.

More about private pension insurances in Germany

One ETF is not the other

You might expect that every ETF that tracks an index like for example the S&P 500 has the same performance. That is not the case! You can find ETFs that outperform slightly but robustly, and those that underperform significantly. Selecting the right ETF for your index is pretty important.

We've checked which ETF in a given class performs better inclusive of all costs and hidden gains. For example, for the S&P 500, we can save you an expected 0,25% which can add up to quite a considerable amount over a longer investment period and with a growing portfolio value.

Choosing the right index or benchmark is crucial 

As the professionals will tell you: 95% of your return is about picking the right benchmark i.e. composition of indices that you want to track. A disciplined investor has such a benchmark and then tracks under or outperformance. But short of going all the way. 

Let's first just be realistic and avoid the many big pitfalls:

  • As a long-term investor, do not fall into the trap of the many guaranteed products. In the long run, a good index is safe. We see so many examples of guarantees that ruin the returns.

  • Do not choose an index based on short-term data. Insurance companies and trading platforms show you often just data of 3-5 years. That does not tell you a darn thing. We look at total return data over the lifetime of the index and compare them to indices for which we have the longest time series (of up to 150 years).

For example, the MSCI world index shows 11% return since its start, and everyone nowadays seems to think that that is the best choice. High return, well spread. BUT this period was just a very good period for stocks. Other indices like the S&P outperformed the MSCI by 1%. More fundamentally 11% is not a sustainable stock return. A sustainable stock return is about 7%: the sum of nominal GDP growth plus dividend yield/stock buy backs. If the return would be higher profits of companies would take up the entire GDP, and that would not work.

We have some basic tools to help select a benchmark based on long-term returns and risk to the indices (based on historic data and fundamentals) and the region in which you are most likely to retire. 

Get advice on the selection and structuring of your private pension insurance

Automatic rebalancing

In case you are wondering if you should trade your portfolio at all? Virtually anyone will want to adjust their portfolio over time based on their benchmark. This is what the profs call rebalancing. So if you have 2 ETFs that have an ideal weight of 50% each, then for example at year-end you find that due to price movements the weights have shifted to 40-60. At that point, profs would rebalance the portfolio back to 50-50 which involves selling some of one ETF and buying some of the other. 

The profs do this, as most good indices over time display some mean reversion. So selling the expensive and buying the cheap index, then means over time an extra gain as you usually sell high and buy low.  

We have created a simple algorithm that does the rebalancing for you, making this worry-free for you.

Rebalancing also makes sense when you get older, or you have experienced losses elsewhere you want to de-risk. Shift towards more stable investments, like ETFs that hold rented properties. This then also involves buying and selling ETFs. A tax wrapper then helps you preserve your capital. 

We are creating a tool that helps you in this big-picture rebalancing. This shift is complex. It depends not just on your age, but also on how successful you have been in investing, what other pension buffers you have, and your other goals and constraints. 

Benefit from our recommended private pension insurance

Structuring your tax wrapper 

You should consider structuring your portfolio such that you have even more tax benefits. Since you need to take the pension/PRV as a lump sum to make the most of the tax wrapper, it makes sense for most people to take it in different tranches. Eg., instead of it all being paid out at the age of 67, you can have the PRV paid in different tranches. So then the investment can accumulate longer in a tax free way ! Also, make sure you can postpone the pay-out so that in retirement you can fine-tune when you need the money.

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Dr. Christian Mulder

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