It was a very unfortunate event when I met with the Witholding Tax which I will refer as WTH in short in the rest of this article. I am a Non-US resident and any income I earn as in Dividend payments or interest payments from the funds listed in the USA are subject to 30% WTH. This is a US Government tax. When I started my interest in the Emerging Market Government Bonds I did some research on EMD . Rather than buying individual Emerging Market bonds this ETF was the dream investment vehicle for me. I did put all my money into this ETF so I distributed the risk as this ETF holds so many different countries government bonds e.g. Indonesia, Brasil, Russia, Mexico, Peru, China, Turkey etc. Average coupon rate is around 5% net to you after the ETF expenses. This ETF is trading at $16 per share so you can start with a small investment. If you are to buy a government bond of Mexico for ex the minimum investment is $200K. Have a read about my page Fixed Income to learn more about investing in these bonds directly. Anyway I invested in EMD and I was getting coupon payments so called as Distributions every month. It is quite complicated to calculate the percentage from these payments. Let me dig in to these for you so that you can calculate for yourself.
Every month this EMD ETF is distributing $0.10 per share, you can think these like dividends on a stock. Let’s take it for a year it is $0.10 * 12 = $1.20 per share. Share price is around $15 goes up and down of course, assume $15 for now and it is a whopping 8% return at this price. But hold on before you get excited to rush in buying in this ETF. There is WTH that eats up 30% of this payment before it even gets to you. In the case of 8% return from the asset, you actually get 5%. That is not a good return when I can get 10% on Government Bonds.
You can get a discounted rate for WTH if there is a tax treaty agreement between the foreign country and US. The United States has tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries are taxed at a reduced rate, or are exempt from U.S. taxes on certain items of income they receive from sources within the United States. This is getting a bit complicated yeah? I find the tax matters always complicated somehow. When I give my broker a call to ask about tax implications they simply say “Sorry sir, we cannot advise on tax matters” and they say you better consult to a tax adviser.
The keyword is “Domicile” for example you want to invest in S&P500 index fund. I think the best ETF company for the index funds is Vanguard. So I check what is the symbol to trade in order to start my investment. I can find VOO or VUSD they both track S&P performance. Let’s have a look at VUSD details;
Did you notice the highlighted area Domicile: Ireland? This means if you invest in this ticker symbol of VUSD you only pay 15% from your income from this asset every quarter instead of 30% if you invested in US domicile VOO. So always understand the Domicile of the ETF you are investing in. Also currency matters Vanguard has other tickers for all kinds of currencies listed in different exchanges e.g. VUSA for Euro.
You have to watch out for the cost of each ETF also. The cost depends on which index they are listed in mainly. Let’s take VUSD and VOO as an example VUSD ETF management cost is 0.07% where VOO is 0.03%. Do not forget the dividend yield is around 2% per year and the WTH difference of 15% VUSD vs 30% VOO. So if you are an investor outside USA and want to invest in a index fund for your FIRE which one is better for you in the long term?
We have to do some calculation now. You invest in $10K in VUSD, your annual fee would be $7. Assuming 2% annual dividend payment you would get $200 dividends and then you get a cut of WTH 15% which equals to $30.
VUSD annual return : – 7$ +$200 – ($200*0.15=$30) =$ 163
Now lets compare it to VOO again invest in $10K, your annual fee would be $3. Assuming 2% annual dividend payment you would get $200 dividends and then you get a cut of WTH 30% which equals to $60.
VOO annual return : -3$ + $200 -$60 = $137
So VUSD is the winner due to lower WTH. Also it is worth noting VOO is holding $540 billon of funds where VUSD is only $25.8 billions. This makes sense as majority of investors are based in the US.