Never bet against America!
A tax efficient way to invest in the compounding powers of US companies
Never bet against America! That’s not hard to remember, is it?
After what looked like a torrid 2022, and what looked like a tepid start and middle of this year, S&P 500 is exactly back to where it was at the beginning of Jan 2022, while hitting an all time high on a total return basis1.
S&P 500 is the mother of all indices when it comes to long term passive investing, for a variety of reasons:
It represents 500 companies, so diversification is amply built in
It captures the entrepreneurial energy of the American capitalism, one that seems to be powered by elixir
Unlike the NASDAQ-100, it has less volatility and represents a broader sector of the economy, so will likely hold on to its gain in varied conditions. In 2022, QQQ lost 33% while SPY lost a mere 19% and the incremental gains for QQQ in this period was a mere 3%.
A lot of people have scepticism about S&P 500, and I am happy to take on a few here:
It’s overpriced - probably it is, but who cares? If the constituent companies can continue to produce the results, and it operates in an economy that seems to be best of all developed world economies, and capture more of the innovation and creative destruction that happens in progress of a society, then why shouldn’t be? In other words, I am arguing that perhaps being overpriced is because the quality of its constituent companies are better than the constituent companies in other markets
It’s concentrated on a few stocks - it indeed is - but that’s the magic of the index. It self-selects the best features of the constituents in a way that individuals can’t. The magnificent seven are liked by investors and the index has caught that trend perfectly.
It’s focussed too much on the US - maybe it is, but that’s probably fine. The top end of the constituents - the magnificent seven are all global companies powering software, technology and media we use in every part of the world, so the global aspect of it is built in. Unless the world can keep up with America’s ability to produce global economic super-winners like Microsoft, Apple and Google, there is every justification for US to be choice destination for investors.
When I was constructing the coffee can portfolio, I was aware of all of these aspects, which is why I built in a healthy 36% allocation into the US constituents, but (a) that hasn’t been enough and (b) even with the 36% allocation, the weights I have chosen have been too little for the ones that have performed the most.
To be clear, I am not saying that there are no risks. Can it go through another 20-30% decline in the medium term? Yes. Can concentration in magnificent seven turn ugly when investors turn their backs on them? Yes. Is it likely overpriced and go through a correction? Possibly. I am not blind to the risks. I am claiming that the resilience of the components of the index, and size of the index (500 stocks) allows it to come back again and again and if that is the premise, then for regular investors, the volatility isn’t much of an issue, and probably offers the opportunity to average entry prices in their favour.
Am I saying that my Coffee Can Portfolio is wrong? Not yet. I am happy with the allocation I have made and I think that over a long period of time, the volatility adjusted returns from this portfolio will likely be superior, but that is yet to be seen.
What I can say with confidence is that any investor who builds their future wealth through regular investments in S&P 500 will probably do just fine, leading to a simple and profitable way of building wealth. Doing so systematically is a good way to deal with the volatility that the market automatically poses.
If you are convinced that S&P 500 is a good place to invest in, then what’s the best vehicle to do so? For anyone who lives outside of the US, dividends from S&P 500 ETFs are taxable at source - i.e. the US government enforces a dividend withholding tax of between 15%-30%2, depending on your residency. This tax is payable in most tax-optimised instruments in local jurisdictions like ISA in the UK or SRS in Singapore.
This tax is avoidable if dividends are never made out. Luckily for us, Vanguard has launched an ETF, VUAG, that is an Ireland domiciled S&P 500 ETF, trades in GBP and never pays out a dividend. It is an “Accumulation” ETF - i.e. the dividend is automatically reinvested back into the index for investors. I find this ETF a superior way of accumulating interest in S&P 500 than those that pay out regular dividends.
If we just look at the past 2 years, when VUAG has done a round trip from £65.40 all the way down to £55.50 and back up to ~ £70. If you had invested £5000 every month, you would be up 11.83%3 on a compounded basis, while holding VUAG at an average price of £62.74. Power of dollar cost averaging (DCA5).
Put on an automated investment in VUAG and let your wealth build and grow over time. And kids, listen to Warren - Don’t do drugs, and never bet against America!
As always happy investing!
Disclaimer: I may hold positions in the tickers mentioned in this post. I am not your financial advisor and bear no fiduciary responsibility for your actions. This post is only for educational and entertainment purposes. Do your own due diligence before investing in any securities.
The index doesn’t adjust for dividends. To calculate total returns that includes dividend reinvestment, use a calculator like this one.
In Singapore, all S&P 500 ETFs attract 30% dividend tax withholding. For UK, dividend tax withholding is 15% if held in non-tax-optimised account (i.e. normal brokerage account) & ISA, but there is no dividend withholding on Pension/SIPP holdings.
Calculated on GBP basis. In USD basis, returns on this strategy were to the tune of 10.6%, very much comparable.
Accurate at the time of drafting, which happens to be Dec 17, 2023
Given the ETF trades in GBP, Sterling Cost Averaging, or Pound Cost Averaging might be better terminology, but I am sticking to the phrase that is most commonly used for this strategy.