Portfolio in a very small economy (Israel)

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Portfolio in a very small economy (Israel)

Postby t0x1n » Sat Aug 03, 2013 4:29 pm

Hi,

I've read quite a bit about home bias, mostly in this forum, but also in other resources such as vanguard papers. Perhaps the paper that influenced me most in this regard is The role of home bias in global asset allocation decisions. Another useful resource has been the Canadian couch potato (specifically the Global couch potato), in that Canada is a small economy as well.

However, there is small, and there is very small, and I believe Israel falls in the latter category. In addition, there is the matter of considerable instability in our region.

I'm 30 years old (no debts, steady job), so in Bogle's age in bonds spirit I was thinking about the following allocation:

30% Israel total government bond index (about half of which is inflation-indexed)
20% TA-100 Index (the broadest local index I can invest in practically, this can be probably thought of as the equivalent of S&P 500)
30% Vanguard Total Stock Market ETF (VTI)
20% Vanguard FTSE All-World ex-US ETF (VEU)

***EDIT***
Following the advice below, my updated portfolio is now the following:
30% Israel total government bond index (about half of which is inflation-indexed)
10% TA-100 Index (the broadest local index I can invest in practically, this can be probably thought of as the equivalent of S&P 500)
30% Vanguard Total Stock Market ETF (VTI) [in tax-exempt account]
30% Vanguard Total International Stock ETF (VXUS) [in taxable account]

Some considerations:
1. I'm pondering if the Israeli government is reliable enough to be considered as risk-free as it is assumed in the portfolio above (it has been so far).
2. I've over-weighted US stocks over international due to lower commissions and better tax efficiency (it is my understanding that US-domiciled world funds are not tax efficient, and trading in EU markets is expensive and inconvenient here).
3. I don't want to complicate myself with tilting for now (harder rebalancing, higher fees, more transactions, etc. [we don't have commission free brokers here]).
4. I am aware of the possibility of international brokers (such as Interactive Brokers), however this considerably complicates my tax reports, incurs high wire fees, and generally complicates my financial life.

***EDIT***
Regarding global bonds, consider the following article by vanguard: Global fixed income - considerations for US investors
Intuitively, if the components of international bond returns are imperfectly correlated with those of U.S. bond returns, it stands to reason that a diversification benefit should ensue: Overall portfolio volatility should be reduced. However, Figure 4 reflects the reality that any such correlation benefit is over whelmed by the sheer magnitude of the currency volatilities shown in Figure 3. In other words, the currency exposure inherent in international bonds dominates their volatility, negating any diversification benefits that might be expected otherwise.

Assuming one can apply this finding to other countries (seems reasonable), it seems that an NIS (shekel) - hedged bond fund would be the way to go. Unfortunately, we don't have such an ETF (we have an ETN that does this [0.8% TER], but I steer clear of those). The paper also recommends 20%-40% global exposure in the bond allocation, so for a 70-30 portfolio that comes out to 6%-12% which doesn't seem that meaningful anyway. I did find one interestinf ETF in this regard, which tracks emerging market government bonds. Perhaps that should warrant allocation?

Your advice will be greatly appreciated.
Thanks!
Last edited by t0x1n on Mon Aug 05, 2013 6:16 am, edited 2 times in total.
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Re: Portfolio in a very small economy (Israel)

Postby asset_chaos » Sat Aug 03, 2013 8:58 pm

You're thinking this through and making a Boglehead-ish investing plan. That's more important than the last, fine gradations of that plan. Make a plan you can stick to, save to fund that plan, and financially you'll be successful. A few remarks:

A look at the Wikipedia page for the TA100 says that the largest 4 companies account for 30% and the top 10 for 60% of the index weighting. That's one of the problems with small markets. Even the broadest of domestic indexes are dominated by just a few companies. In this case too you'll also invest in most of the TA100 weight again through the foreign stock funds. Going to Vanguard's holdings page for the total world stock fund https://personal.vanguard.com/us/funds/snapshot?FundId=0628&FundIntExt=INT#tab=2 says that Israeli companies account for 0.2% of global stock market capitalization, the same as Chile, Poland and Turkey---more than Ireland and less than Belgium. (Canada is around 4%.) Far be it for me to tell you how much to invest in your home country, but you're taking on significant concentration risk in the stocks. For context, an American who goes 100% domestic stocks is overweighting the US relative to global markets by a factor of 2. You're overweighting Israel by a factor of 250. You need to be certain you're 100% comfortable with that.

I disagree about total world funds being tax inefficient. The EFT VT may cost a bit more than the VTI-VEU combo in expense ratio, but the tax situation is virtually identical: either will be highly tax efficient. And if commissions are a significant cost, I'd have thought one larger purchase of a single fund would be less costly than smaller purchases of two separate funds.

On the bonds, I have no specific knowledge on the credit-worthiness of the Israeli government. (If you look it up, S&P gives them an A+ local currency rating, for whatever that's worth.) I don't consider Israel in the class of countries that routinely defaults or devalues their currency to in essence confiscate from their lenders. If your living expenses are in shekels, then having your bonds denominated in shekels is a good idea. The age in bonds is a fine, conservative rule of thumb.

Good luck.
Regards, | | Guy
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Re: Portfolio in a very small economy (Israel)

Postby Duckie » Sat Aug 03, 2013 9:30 pm

t0x1n, check out some of the comments on this thread.
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Re: Portfolio in a very small economy (Israel)

Postby Noobvestor » Sat Aug 03, 2013 9:33 pm

asset_chaos wrote:
I disagree about total world funds being tax inefficient. The EFT VT may cost a bit more than the VTI-VEU combo in expense ratio, but the tax situation is virtually identical: either will be highly tax efficient. And if commissions are a significant cost, I'd have thought one larger purchase of a single fund would be less costly than smaller purchases of two separate funds.


I would add, too, that I would expect VT's expense ratio to keep coming down as more people invest in it - plus that little extra expense savings you some headaches with rebalancing, etc... ;)
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Sun Aug 04, 2013 3:35 pm

Thank you all for the thoughtful responses !

@duckie
Nice catch, thanks ! I actually looked for similar threads in the past but this is indeed a new one I hadn't noticed.

@asset_chaos
my concern regarding the tax efficiency of US-domiciled international funds has to do with dividends in taxable-exempt accounts. It is my understanding that the fund itself pays withholding taxes, whereas in an Israeli (or US) fund I evade that tax in such an account. Perhaps this just means that I need to have my international fund in my taxable account ?

Regarding the stock allocation, you and Valuethinker from the other thread (as well as a decent local Israeli blogger) present a convincing case. Perhaps my allocation should look like this:

30% Israel total government bond index (about half of which is inflation-indexed)
10% TA-100 Index (the broadest local index I can invest in practically, this can be probably thought of as the equivalent of S&P 500)
30% Vanguard Total Stock Market ETF (VTI) [in tax-exempt account]
30% Vanguard FTSE All-World ex-US ETF (VEU) [in taxable account]

With regard to international bonds, I didn't see any ETF that invests in international government (sovereign) bonds. Perhaps I should take a mix of Vanguard Short-Term Government Bond ETF (VGSH) and Vanguard Long-Term Government Bond ETF (VGLT) ?
*EDIT* having read Vanguard's Global fixed income - considerations for US investors which advocates hedging of international bonds, I'm not sure I'll have this asset class in my portfolio at all since we don't have any good hedged securities for it here. The paper also recommends 20%-40% global exposure in the bond allocation, so for a 70-30 portfolio that comes out to 6%-12% which doesn't seem that meaningful anyway.

Again, your thoughts would be appreciated !
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Re: Portfolio in a very small economy (Israel)

Postby Duckie » Sun Aug 04, 2013 6:24 pm

t0x1n, instead of Vanguard FTSE All-World ex-US ETF (VEU) I'd pick the Vanguard Total International Stock ETF (VXUS). It's a little more complete.
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Re: Portfolio in a very small economy (Israel)

Postby nedsaid » Sun Aug 04, 2013 9:45 pm

If I lived in a small economy nation, I would be very tempted to have a lot of my fixed income investments invested internationally as well.

The stock investments look great.
A fool and his money are good for business.
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Mon Aug 05, 2013 4:27 am

@Duckie
Thanks for the suggestion! My portfolio would now be:

30% Israel total government bond index (about half of which is inflation-indexed)
10% TA-100 Index (the broadest local index I can invest in practically, this can be probably thought of as the equivalent of S&P 500)
30% Vanguard Total Stock Market ETF (VTI) [in tax-exempt account]
30% Vanguard Total International Stock ETF (VXUS) [in taxable account]

@nedsaid
Regarding global fixed income, please see my comments at the bottom of this post and at the bottom of this post. Do they make sense?
*EDIT* The only hedged ETF I found tracks emerging market government bonds, perhaps I should allocate some to that ?

Thanks again
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Re: Portfolio in a very small economy (Israel)

Postby asmodeus » Mon Aug 05, 2013 5:02 am

@t0x1n

1.how do you plan to hedge the foreign, dollar denominated ETFs?
2. Regarding the tax exempt account, is this an IRA based "keren hishtalmut"?

thanks
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Re: Portfolio in a very small economy (Israel)

Postby kramer » Mon Aug 05, 2013 5:31 am

My intuition tells me that 40% allocation to the Israeli economy (about 1.5% the size of the US economy) is much too high.

And if you are currently employed, even more of your financial future is tied to the Israeli economy. For an employed person, they should under-allocate to their country because their human capital is partly tied to its success, this is less true of a retiree.

Also, when you are older will you be collecting some kind of government pension from Israel, denominated in Shekels?

Part of this comes down to the behavior of the Shekel, which I am not too familiar with. Most goods sold in Israel are imported. And the USA is the largest trading partner, by far. And there is not much regional trade due to economic embargoes by the Arab countries and also their small economies. So my best guess is that the prices you are paying are often effectively worldwide prices and largely tied to the dollar and to a lesser extent the other major currencies.
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Mon Aug 05, 2013 6:02 am

t0x1n wrote:Hi,

I've read quite a bit about home bias, mostly in this forum, but also in other resources such as vanguard papers. Perhaps the paper that influenced me most in this regard is The role of home bias in global asset allocation decisions. Another useful resource has been the Canadian couch potato (specifically the Global couch potato), in that Canada is a small economy as well.

However, there is small, and there is very small, and I believe Israel falls in the latter category. In addition, there is the matter of considerable instability in our region.

I'm 30 years old (no debts, steady job), so in Bogle's age in bonds spirit I was thinking about the following allocation:

30% Israel total government bond index (about half of which is inflation-indexed)
20% TA-100 Index (the broadest local index I can invest in practically, this can be probably thought of as the equivalent of S&P 500)
30% Vanguard Total Stock Market ETF (VTI)
20% Vanguard FTSE All-World ex-US ETF (VEU)

Some considerations:
1. I'm pondering if the Israeli government is reliable enough to be considered as risk-free as it is assumed in the portfolio above (it has been so far).
2. I've over-weighted US stocks over international due to lower commissions and better tax efficiency (it is my understanding that US-domiciled world funds are not tax efficient, and trading in EU markets is expensive and inconvenient here).
3. I don't want to complicate myself with tilting for now (harder rebalancing, higher fees, more transactions, etc. [we don't have commission free brokers here]).
4. I am aware of the possibility of international brokers (such as Interactive Brokers), however this considerably complicates my tax reports, incurs high wire fees, and generally complicates my financial life.

Your advice will be greatly appreciated.

Thanks!


My one thought is that you should not have much, if any, Israeli index. 10% at most. It's too small a portion of world markets.

On bonds, you could take the 10% off the Israeli index, and put it into a global government bond fund? If that does not work from a taxes and expenses point of view, then you could keep the 70/30 allocation, but put the balance into international equities.
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Mon Aug 05, 2013 6:06 am

@asmodeus

1. I don't plan to, I'll explain why in your post.
2. Yes.

@kramer
Thanks for your insights. I've updated the original post to reflect my current portfolio.
Regarding my pension, indeed I have a government plan which will pay in NIS (shekels). I don't have much control over it though, beyond the fact that it is somehow similar to a Target Fund model (bonds in relation to age, and using broad local and foreign indexes).

Your points regarding USD are well taken, even though I wasn't overly worried about currency fluctuations to begin with. asmodeus - that's part of my explanation to your first question.

@Valuethinker
Thanks for your help! I've updated the original post to reflect my current portfolio as well as my position regarding international bonds. As I mention in the edit, my only viable option for now seems to be an emerging markets government fund, so I'm wondering if that has a place in my portfolio.
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Mon Aug 05, 2013 8:52 am

t0x1n wrote:@Valuethinker
Thanks for your help! I've updated the original post to reflect my current portfolio as well as my position regarding international bonds. As I mention in the edit, my only viable option for now seems to be an emerging markets government fund, so I'm wondering if that has a place in my portfolio.


Because the risk of Emerging Market bonds correlates with crises (when there is a crisis, usually some EM or another goes broke-- 2008 something of an exception) and EM bonds therefore show equity like risk characteristics (the yield spread moves out against the US Treasury when financial markets are worried about risk, thus the prices go down), I would not use EM Bonds. I would hold more inflation linked Israeli government bonds instead (being the safest fixed income securities you can invest in).

I think I posted this on another thread to you as well.
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Mon Aug 05, 2013 10:10 am

@Valuethinker
Thanks for the explanation.
I take it you advocate a higher percentage of inflation-linked Israeli government bonds (as opposed to the nominal variety) ?
What would be an allocation that makes sense ? 70% linked and 30% nominal? Maybe even 100% linked and 0% nominal ?
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Mon Aug 05, 2013 10:41 am

t0x1n wrote:@Valuethinker
Thanks for the explanation.
I take it you advocate a higher percentage of inflation-linked Israeli government bonds (as opposed to the nominal variety) ?
What would be an allocation that makes sense ? 70% linked and 30% nominal? Maybe even 100% linked and 0% nominal ?


In principle 50/50 is OK, *but* if you decide to reduce equities (or money markets) then inflation linked bonds should be the safest and least volatile investments. I think 2/3rds index linked/ real return bonds/ inflation linked and 1/3rd nominal is a relatively safe combination.

Maybe Israel never has hyperinflation again. But it did once, and that makes me cautious-- in the mid 80s Israel was running 100% inflation as I recall.

Let's be clear. Your other risk is political-- an external threat that forces suspension of debt payment (in WW2 this is more or less what the British government did-- rolled over all debt into low interest rate fixed income debt, not redeemable in war time, I believe). I am old enough to remember the day when President Nixon ordered the C5 Galaxies and C141A Starlifters to go in*-- and old enough to remember when Ariel Sharon crossed at Chinese Farm. At that point you will have other more important issues, but we have to at least *consider* these things even if our consideration is to do nothing. I do not believe we will again see such moments *in that form* in my lifetime, btw.

* Wiki tells me this was 'Operation Nickel Grass' and the first plane reached Lod Airport on 14th October 1973. There are many similarities with 'Operation Corporate' in 1981 ie the Falklands-- jets landing at Ascuncion islands. The American naval commander was basically told to give the Royal Air Force whatever jetfuel it asked for- -which turned out to be hundreds of thousands of tonnes.
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Mon Aug 05, 2013 11:02 am

In principle 50/50 is OK, *but* if you decide to reduce equities (or money markets) then inflation linked bonds should be the safest and least volatile investments

What do you mean by "reduce equities" ? Lower their percentage from 70% to a lower figure ? Why would that affect my linked / nominal bond distribution ?
Also, thanks for the history lesson - it looks like you know more about Israeli history than I do :D
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Mon Aug 05, 2013 11:13 am

t0x1n wrote:
In principle 50/50 is OK, *but* if you decide to reduce equities (or money markets) then inflation linked bonds should be the safest and least volatile investments

What do you mean by "reduce equities" ? Lower their percentage from 70% to a lower figure ? Why would that affect my linked / nominal bond distribution ?

Also, thanks for the history lesson, it looks like you know more about Israeli history than I do :D


Re history: I am just *older* than you are, I suspect-- so I remember the 1970s, a difficult and volatile time in many countries. There are many bad things about US president Nixon, but he was forthright in a crisis, and he had the right advisers. In 1973, even though Watergate was already besieging his Administration and he himself was showing dangerous instability and alcoholism, he was on the side of the angels. God has always flown in the cockpits of the the USAF. In the same way we were lucky, the US SECDEF in 1981 was Caspar Weinberger, a confirmed Anglophile-- we hung by a thread in the South Atlantic, without the US we'd never have pulled it off.

Likewise Sharon has many detractors. He was always a gambler and at Chinese Farm he pulled it off, the guerilla spirit that Brigadier Wavell taught the Palmach lived on. I would that destiny had given Sharon one more throw of the dice.

On percentages.

The lowest correlation (theoretically) is between inflation linked bonds and equities-- the two should behave very differently (in practice, this is not so much the case). That would give the greatest diversification benefits.

However you need to be careful of taxes. How does your tax system treat 'phantom' gains on inflation linked bonds (ie the increase in value due to increase in CPI). In some systems, that gain is *taxable* which significantly reduces the benefits of owning such bonds (under high inflation, your protection just gets taxed away).

My logic (which is not necessarily good but this is how it runs):

- you need 10% in anything to make a meaningful difference
- so if you are 30% bonds, then 20% inflation linked/ 10% nominal is fine, and 15% each would not make much difference. If interest rates go down then you'd rather be in the nominal bonds
- if you increase your bonds from there, then I'd rather be in inflation linked on the general principle this is dead safe money (you may get price volatility, but, fundamentally, you know your buying power in shekels is preserved)
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Mon Aug 05, 2013 12:29 pm

Valuethinker,

Thanks again for the dual lesson !
As for taxation, in Israel most mutual funds are tax-exmpt, which means the only taxable event (for local underlying securities at least) occurs when you sell the fund, upon which you pay 25% on the real return on the entire fund. I therefore don't see a taxation difference between linked and nominal bond funds (please correct me if I'm wrong).

While we're on the subject of taxation, it appears I was wrong in my understanding of US dividend taxes, and they are apparently withheld - even in tax exempt accounts.
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Tue Aug 06, 2013 8:05 am

t0x1n wrote:Valuethinker,

Thanks again for the dual lesson !
As for taxation, in Israel most mutual funds are tax-exmpt, which means the only taxable event (for local underlying securities at least) occurs when you sell the fund, upon which you pay 25% on the real return on the entire fund. I therefore don't see a taxation difference between linked and nominal bond funds (please correct me if I'm wrong).

While we're on the subject of taxation, it appears I was wrong in my understanding of US dividend taxes, and they are apparently withheld - even in tax exempt accounts.


It sounds like, then, subject to expense ratios, you can hold Index linked bonds to your heart's content. It should be the lowest risk option in terms of your fixed income holdings.

(I am not sure 'lesson' is appropriate word vis a vis Israeli history-- let's just say I paid attention. Sandy Woodward, the commander of the British task force to the Falklands in 1981 has just died, and so, maybe, these now dim events (Sharon was very much in the news at the same time) are in the front of my mind-- and if you lived through the 1970s, the events around the 1973 war and Oil Embargo were pretty salient, too). Woodward was a sometimes abrasive character, but his flotilla was in the middle of an Atlantic exercise when the Argentines struck, and so it was his job to head the Task Force, to achieve the impossible an amphibious landing without air superiority over the beachhead -the Royal Navy was full of such characters, people who might hurt feelings, but who did not accept failure as an option).
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Wed Aug 21, 2013 9:11 am

Valuethinker,

I apologize for my late response, it took me a while to get clear answers, but now I'm rather convinced that taxes on dividends from all foreign stocks (US included) are withheld, even in tax-exempt accounts. This gives a taxation advantage to Israeli stocks - would you say that merits an allocation of more than 10% ? maybe 15% ? 20% ?

Thanks again !

(It's a good thing someone's paying attention to Israeli history, I know I don't :wink: )
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Fri Aug 23, 2013 4:06 pm

Bump :greedy
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Fri Aug 23, 2013 4:38 pm

t0x1n wrote:Valuethinker,

I apologize for my late response, it took me a while to get clear answers, but now I'm rather convinced that taxes on dividends from all foreign stocks (US included) are withheld, even in tax-exempt accounts. This gives a taxation advantage to Israeli stocks - would you say that merits an allocation of more than 10% ? maybe 15% ? 20% ?

Thanks again !

(It's a good thing someone's paying attention to Israeli history, I know I don't :wink: )


My actual interest in the history of the region is the period around 550-600 AD, when it's still part of the Byzantine (ie Eastern Roman) empire-- amateur interest, but that's another story ;-).

In other countries:

- if you hold shares of foreign companies in a tax exempt account, you can't usually claim back the tax credit

- if you hold them in a taxable account, there is usually a tax treaty, and you can offset the tax you paid on, say, US stocks, against your Israeli taxes. Hard to believe there is not a US-Israeli tax treaty given how many Americans live in Israel and vice versa

The rules around collective investment vehicles (like ETFs) are complex (to say the least!). For example, in the UK if they are listed on Dublin, you are usually OK. If they are listed in New York, the UK government treats all distributions as income tax (no capital gains). At least that's the 1 line summary.

So you will need to understand Israeli tax laws.

http://us.ishares.com/product_info/fund ... ew/EIS.htm tells me how concentrated the Israeli index is (note that they cap the index, presumably to prevent Teva pharmaceuticals being more than say 20% of the index-- you'd half to look at the MSCI index definition to see why they do that, but that's my guess).

It's not hugely diversified: more than half of it is Teva + financials.

You will have to estimate the tax drag. If US stocks pay dividends of c. 2.5% and European say 3.5% (Japan about 1.5% I think) and you pay say 25% of that in holding taxes, that's a c. 0.6% additional performance drag in the USA, 0.875% in Europe etc.

I would *still* heavily tilt away from Israel given the diversification issues, but 10-20% of your total portfolio (of stocks and bonds) is risky by not excessively so if you hold it in your home country. The same macroeconomic factors that move other markets move Israeli markets, with an especially strong correlation with USA I suspect. As I say your main issue then is you are adding the one uniquely Israeli risk -- political risk (other countries have political risk but political risk in most developed countries is not 'with live ammunition' so to speak ;-)).

Note that portfolio theory says if you are underdiversified the most gains from diversification come from having less correlated assets. That *probably* (I state without knowing) means you should hold more European and Far Eastern assets, and less US stocks ie if your total overseas diversification is limited. However I would not deviate too far from global market cap weightings (US is c. 50% of world indices, you'd have to check the exact weighting).

The other thought is can you avoid the withholding tax problem by holding say US Treasury bonds ETF? Then take some of your bond weighting and move it into that-- you are getting currency diversification still, and you are holding some of your money (ie bonds) in a way that diversifies away from Israeli-specific risks (currency, inflation, political).
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Tue Aug 27, 2013 10:05 am

Valuethinker,

As always your posts are very valuable :)

I apologize for the delay, but it took my some time to get the facts.
It seems that by investing in Europe rather than the US I can reduce dividend taxation in my tax-exempt account (for example in the US - from 25% to 15%).

Incorporating your suggestion to a slight compensation towards world ex-US stocks (due to Israel's correlation with the US), here's what I came up with:

IRA account (tax-exempt)
10% TA-100 Index (completely tax-exempt)
25% FTSE All-World ETF (15% withheld tax on US dividends, possibly similar figures for other countries' dividends) [This is the only total world European ETF I found]

Bank account (taxable)
30% Israel total government bond index (about half of which is inflation-indexed, I may tilt towards inflation-indexed in the future)
15% Vanguard Total Stock Market ETF (VTI)
20% Vanguard Total International Stock ETF (VXUS)

Total
Israel bonds 30%
Israel stocks 10%
~25% Total US
~35% World ex-US

Any advice will be appreciated 8-)
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Sat Aug 31, 2013 4:33 pm

Bump ? :o
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Sat Aug 31, 2013 4:56 pm

t0x1n wrote:Valuethinker,

As always your posts are very valuable :)

I apologize for the delay, but it took my some time to get the facts.
It seems that by investing in Europe rather than the US I can reduce dividend taxation in my tax-exempt account (for example in the US - from 25% to 15%).

Incorporating your suggestion to a slight compensation towards world ex-US stocks (due to Israel's correlation with the US), here's what I came up with:

IRA account (tax-exempt)
10% TA-100 Index (completely tax-exempt)
25% FTSE All-World ETF (15% withheld tax on US dividends, possibly similar figures for other countries' dividends) [This is the only total world European ETF I found]


I confess c onfusion. Is it an all world ETF or a European ETF?

Do you mean a global index ETF listed in Europe?

When you say 'investing in Europe' do you mean investing in a Europe-listed vehicle?

Did you check on recoverability of withholding taxes paid in US and Europe against Israeli taxes? Because if allowable, you might want to hold these in the taxable account, and hold the Israeli bonds in the tax exempt account?

Bank account (taxable)
30% Israel total government bond index (about half of which is inflation-indexed, I may tilt towards inflation-indexed in the future)
15% Vanguard Total Stock Market ETF (VTI)
20% Vanguard Total International Stock ETF (VXUS)

Total
Israel bonds 30%
Israel stocks 10%
~25% Total US
~35% World ex-US

Any advice will be appreciated 8-)

[/quote]

Your overall asset allocation is fine and the sort of thing I was thinking of. (note that USD 1000 into Israeli stocks turns out to be $200 USD into one company, Elan Pharmaceuticals!).

I am just not sure about the taxable location issue-- I am not sure what is going on here.
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Sat Aug 31, 2013 5:38 pm

I confess confusion. Is it an all world ETF or a European ETF?
Do you mean a global index ETF listed in Europe?

Indeed, the FTSE All-World ETF is an Ireland-domiciled ETF tracking the global FTSE All-World Index.

When you say 'investing in Europe' do you mean investing in a Europe-listed vehicle?

Yes, I apologize for my unclear wording.

Did you check on recoverability of withholding taxes paid in US and Europe against Israeli taxes? Because if allowable, you might want to hold these in the taxable account, and hold the Israeli bonds in the tax exempt account?

The jury is still out on that (in this thread [Hebrew]). However, even if possible, it will require the submission of detailed annual reports (which I wouldn't have to file otherwise), something I won't have the energies for (and paying an accountant will probably cost more than it will save in this case). Besides, how would this calculation work for a total world fund? Wouldn't there be too many countries with different withholding taxes complicating the process ?

Your overall asset allocation is fine and the sort of thing I was thinking of. (note that USD 1000 into Israeli stocks turns out to be $200 USD into one company, Elan Pharmaceuticals!)

Don't you mean Teva Pharmaceuticals ?

I am just not sure about the taxable location issue-- I am not sure what is going on here.

My current understanding is as follows. There are two ETF dividend taxation considerations :

The tax treaty between the country in which the ETF is domiciled and the country in which the firm distributing the dividends resides.
The tax treaty between the country in which the ETF is domiciled and Israel.

My research suggests that Ireland-domiciled ETFs optimize the above factors, at least in tax-exempt accounts. I'm reasonably sure that in such accounts, these ETFs will reduce US dividend taxation from 25% to 15%. As I understand it they will also be preferable for Europe and emerging markets investments.

Thanks again :sharebeer
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Sun Sep 01, 2013 10:19 am

t0x1n wrote:
I confess confusion. Is it an all world ETF or a European ETF?
Do you mean a global index ETF listed in Europe?

Indeed, the FTSE All-World ETF is an Ireland-domiciled ETF tracking the global FTSE All-World Index.

When you say 'investing in Europe' do you mean investing in a Europe-listed vehicle?

Yes, I apologize for my unclear wording.

Did you check on recoverability of withholding taxes paid in US and Europe against Israeli taxes? Because if allowable, you might want to hold these in the taxable account, and hold the Israeli bonds in the tax exempt account?

The jury is still out on that (in this thread [Hebrew]). However, even if possible, it will require the submission of detailed annual reports (which I wouldn't have to file otherwise), something I won't have the energies for (and paying an accountant will probably cost more than it will save in this case). Besides, how would this calculation work for a total world fund? Wouldn't there be too many countries with different withholding taxes complicating the process ?


In a UK context, I get a statement from the fund 'distributions' and 'tax withheld'. I simply offset that tax withheld against the UK tax I have to pay (capital gains or dividend income). The main hassle is if it is not a 'Distributor' fund from the UK perspective (Irish listed funds are normally Distributor) then all income from the fund is, as I understand it, taxed as *income* not as capital gains-- so a significantly higher tax rate. I arrange my holdings to avoid this problem.

Your overall asset allocation is fine and the sort of thing I was thinking of. (note that USD 1000 into Israeli stocks turns out to be $200 USD into one company, Elan Pharmaceuticals!)

Don't you mean Teva Pharmaceuticals ?
[/quote]

Indeed I did ;-). Elan is an Irish pharma company, subject of a takeover bid.

I am just not sure about the taxable location issue-- I am not sure what is going on here.

My current understanding is as follows. There are two ETF dividend taxation considerations :

The tax treaty between the country in which the ETF is domiciled and the country in which the firm distributing the dividends resides.
The tax treaty between the country in which the ETF is domiciled and Israel.

My research suggests that Ireland-domiciled ETFs optimize the above factors, at least in tax-exempt accounts. I'm reasonably sure that in such accounts, these ETFs will reduce US dividend taxation from 25% to 15%. As I understand it they will also be preferable for Europe and emerging markets investments.

Thanks again :sharebeer

[/quote]

My guess then, and it's only that, is you want your Israeli fixed income in tax exempt accounts (other than that which you need for cash for your emergency reserves). Because you will be subject to higher tax on that than on equities? That at least is the usual advice here for US investors in the same situation, I believe.

To summarize:

- your planned distribution sounds eminently sensible. It ticks the boxes of having inflation linked bonds, having both fixed income and equity, and having global diversification

- I am not entirely sure about taxable location. The usual principle is to put fixed income in the tax exempt account, and equity in the taxable account (because capital gains are taxed less than interest income) *however* that's based on American tax law.

Note in finance if a problem is 'too hard to solve' the best strategy is often to 'split the difference' ie half one way, half the other. The result is you'll never get it totally right, but it's more important to not get it totally wrong (in economic terms, of $200, the utility (gain in pleasure) of the first $100 is greater than that of the second $100, so therefore it's better to know you got the $100, ie split the difference, than to have a 50% chance of 0 and a 50% chance of $200-- this has the same expected value but not the same expected utility).

Off topic, perhaps I should note here that Avon Rubber Products, London Listed plc, manufactures the S10, the standard issue British Army gas mask* ;-). The virtues of global diversification ;-). On the other hand, the solution to the risk of fire in your house is to buy smoke detectors and fire insurance *not* to buy stocks in insurance companies and fire engine manufacturers ;-).

* due to manpower reductions and budget cuts, the British Army may of course not be buying more gas masks, despite the possibility of needing them ;-).
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Sun Sep 01, 2013 11:28 am

In a UK context, I get a statement from the fund 'distributions' and 'tax withheld'. I simply offset that tax withheld against the UK tax I have to pay (capital gains or dividend income).

In Israel, I believe that's done automatically, due to the tax treaty with the US. However my problem is in the case of tax-exempt accounts, where there's no Israeli tax against which to offset - I simply need to be reimbursed for the entire withheld amount somehow. As of now I'm not even sure if that's possible, and even if it is, it involves an annual tedious process I'm trying to avoid. By investing in Ireland-domiciled vehicles I at least minimize the tax drag.

My guess then, and it's only that, is you want your Israeli fixed income in tax exempt accounts (other than that which you need for cash for your emergency reserves). Because you will be subject to higher tax on that than on equities? That at least is the usual advice here for US investors in the same situation, I believe.

With regard to taxation, there is no distinction in Israel between fixed income and equities. It's always 25% on the real return (except for a specific type of bond which I won't buy). Therefore I reckon holding the fixed income in the taxable account makes more sense, as I'd rather pay the 25% on the lower expected return, right ?

I am aware of the Law Of Diminishing Marginal Utility, but I never thought about applying it to investment decisions like this - excellent thinking !
And as always, I enjoyed the tidbits :)
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Re: Portfolio in a very small economy (Israel)

Postby Valuethinker » Sun Sep 01, 2013 1:13 pm

t0x1n wrote:
In a UK context, I get a statement from the fund 'distributions' and 'tax withheld'. I simply offset that tax withheld against the UK tax I have to pay (capital gains or dividend income).

In Israel, I believe that's done automatically, due to the tax treaty with the US. However my problem is in the case of tax-exempt accounts, where there's no Israeli tax against which to offset - I simply need to be reimbursed for the entire withheld amount somehow. As of now I'm not even sure if that's possible, and even if it is, it involves an annual tedious process I'm trying to avoid. By investing in Ireland-domiciled vehicles I at least minimize the tax drag.


Ok in a British context, you *lose* the tax credit then. You have the tax withheld (at source) in the USA, and you cannot get it back, because you are holding it in a tax free account (ditto Canada). So it's better to have the investment where you pay foreign withholding tax in a taxable account.

My guess then, and it's only that, is you want your Israeli fixed income in tax exempt accounts (other than that which you need for cash for your emergency reserves). Because you will be subject to higher tax on that than on equities? That at least is the usual advice here for US investors in the same situation, I believe.

With regard to taxation, there is no distinction in Israel between fixed income and equities. It's always 25% on the real return (except for a specific type of bond which I won't buy). Therefore I reckon holding the fixed income in the taxable account makes more sense, as I'd rather pay the 25% on the lower expected return, right ?


There are couple of factors here:

- if you had very high Israeli inflation, your inflation linked bonds would pay very high returns, which as you say would incur tax

- I think it's important *not* to think too hard about *expected* returns, but about *certain* ones. You can more or less figure out what your current fixed income investments would pay in income, and therefore how much tax you would pay. Ditto the current dividend income from equity investments (taking the last 12 months dividend returns from the funds as a guide-- note we've had an amazing run for stock markets, so capital gains distributions are not likely to be repeated in that scale. My rough guess is US market is yielding 2.5%, European 3.5%, Japan maybe 1.5%-- but you'd have to check that). *that* should be your main way of allocating between taxable and non taxable accounts.

The reason being because expected returns are only expectations, ie uncertain. Whereas tax is a *certain* cost, just like Expense Ratios. So you should seek to minimize taxable cost *now*. However I concede in the long run equities in taxable could give you a capital gains tax problem.

I stress I only imperfectly understand Israeli taxable situation in this.

I am aware of the Law Of Diminishing Marginal Utility, but I never thought about applying it to investment decisions like this - excellent thinking !
And as always, I enjoyed the tidbits :)


Call it the Odessa sense of humour- -I grew up in a somewhat Jewish neighbourhood (all the little shopkeepers were Jewish, and school was virtually empty on Jewish holidays) and watching the films of Woody Allen (also Saturday Night Live (Gilda Radner etc.), Second City TV (Rick Moranis, Eugene Levy etc.)). Neil Simon (Brighton Beach Memoirs, Biloxi Blues) etc. etc. So as much as a Gentile can, I think I 'get' the Jewish sense of humour.

I don't know if they have been translated into Hebrew, but you might like the thrillers of Alan Furst. All set around characters trying to dodge the Gestapo in 1930s and early 1940s Europe (the same world as the film 'Casablanca').

http://www.fantasticfiction.co.uk/f/alan-furst/

something like Dark Star (longer, but good). The World at Night/ Red Gold. They are immaculately researched. One of the themes is trying to get people 'out' of the Nazi clutches and out of Europe.
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Re: Portfolio in a very small economy (Israel)

Postby t0x1n » Sun Sep 01, 2013 5:00 pm

Ok in a British context, you *lose* the tax credit then. You have the tax withheld (at source) in the USA, and you cannot get it back, because you are holding it in a tax free account (ditto Canada). So it's better to have the investment where you pay foreign withholding tax in a taxable account

I believe the possible tax credit on withheld dividends is marginal compared to the long term benefit of the lack of taxation on capital gains (like you said, in the long run equities in taxable could be problematic).

Call it the Odessa sense of humour- -I grew up in a somewhat Jewish neighbourhood (all the little shopkeepers were Jewish, and school was virtually empty on Jewish holidays) and watching the films of Woody Allen (also Saturday Night Live (Gilda Radner etc.), Second City TV (Rick Moranis, Eugene Levy etc.)). Neil Simon (Brighton Beach Memoirs, Biloxi Blues) etc. etc. So as much as a Gentile can, I think I 'get' the Jewish sense of humour.

Seems to me you are more Jewish than I am - and I lived in Israel all my life !
I have watched a lot of Seinfeld though, hope that counts :wink:

Thanks for the book recommendations, if I ever decide to actually read instead of play video games all the time I'll check them out :D
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