In a high-taxation country [Denmark] I should be gearing my investments, right?

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Digit
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In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by Digit »

[edited thread title to include "Denmark" - moderator prudent]

Currently, I invest by following Jack Bogle’s brilliant strategy. I’m 67% in a global index equity ETF and 33% in cash. (I don’t feel safe about bonds, at the moment.) Very simple.

However, I’m about to move from a nation with zero taxation on capital income to a high-taxation country, in my case, Denmark. From now on, I’ll have to pay 42% of everything I gain from my investments.

At the end of each year, I must tell the tax authorities how much my investments have gained or lost value during the year. If they’ve gained value I have to pay 42% tax of my gains, within a few months; if they’ve lost value, 42% of their loss will be deducted from my general income tax for the year, or, if that’s not possible, transferred as a loss to coming years.

Should this affect my investment strategy? Yes, I think so. And here’s what I plan to do.

After tax, Denmark will leave me with 58% of dividends and long-term gains AND LOSSES. This means that if I change my current equity allocation to 100/58 of what it is in a zero-tax country then my long-term and short-term gains and losses and risk will be exactly as if I still were paying zero capital gains tax.

If I want to preserve the risk, gains, and volatility I currently have with my 67% equity allocation, I should simply change it from 67% to 115% when I move to Denmark.

Of course, this strategy will cost me. I’ll lose dividends from 33% of my capital, which is currently cash in a bank. (That is actually a small plus, at the moment, with negative interest rates.) And I’ll also have to pay interest on a loan, the size of 15% of my capital. This will be very cheap in Denmark, at the moment.

By changing my allocation to equities from 67% to 115%, I will have swapped devastating capital gains tax to what is, in effect, an affordable, flat tax fee.

Yes, it’s an expense, but I can live with it when I get Denmark’s excellent social system in return. And the risk, volatility, and long-term gains of my investment will be completely unaffected – except for interest on those 15%.

What do you think? Does this make sense?
Valuethinker
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Re: In a high-taxation country I should be gearing my investments, right?

Post by Valuethinker »

Digit wrote: Thu Jan 13, 2022 2:10 am Currently, I invest by following Jack Bogle’s brilliant strategy. I’m 67% in a global index equity ETF and 33% in cash. (I don’t feel safe about bonds, at the moment.) Very simple.

However, I’m about to move from a nation with zero taxation on capital income to a high-taxation country, in my case, Denmark. From now on, I’ll have to pay 42% of everything I gain from my investments.

At the end of each year, I must tell the tax authorities how much my investments have gained or lost value during the year. If they’ve gained value I have to pay 42% tax of my gains, within a few months; if they’ve lost value, 42% of their loss will be deducted from my general income tax for the year, or, if that’s not possible, transferred as a loss to coming years.

Should this affect my investment strategy? Yes, I think so. And here’s what I plan to do.

After tax, Denmark will leave me with 58% of dividends and long-term gains AND LOSSES. This means that if I change my current equity allocation to 100/58 of what it is in a zero-tax country then my long-term and short-term gains and losses and risk will be exactly as if I still were paying zero capital gains tax.

If I want to preserve the risk, gains, and volatility I currently have with my 67% equity allocation, I should simply change it from 67% to 115% when I move to Denmark.

Of course, this strategy will cost me. I’ll lose dividends from 33% of my capital, which is currently cash in a bank. (That is actually a small plus, at the moment, with negative interest rates.) And I’ll also have to pay interest on a loan, the size of 15% of my capital. This will be very cheap in Denmark, at the moment.

By changing my allocation to equities from 67% to 115%, I will have swapped devastating capital gains tax to what is, in effect, an affordable, flat tax fee.

Yes, it’s an expense, but I can live with it when I get Denmark’s excellent social system in return. And the risk, volatility, and long-term gains of my investment will be completely unaffected – except for interest on those 15%.

What do you think? Does this make sense?
You need to model extreme stock market events. Eg -30% drop in a single day. -50% over a short period. March 2020 was certainly an "exciting" time to be in markets. I can find you a -80% drop if you want (UK in the mid 70s over 18 months). Then there's Japan. Stock markets are all about event risks: Crash of 29, Crash of 87, Saddam invades Kuwait, planes hit the Twin Towers on 9-11, Lehman Brothers goes broke, Covid breaks out in Italy etc.

By borrowing money against the security of stocks, you are in effect short volatility. A "martingale strategy". In other words, a strategy that can fail catastrophically due to margin calls. Even if in the long run you were right that stocks were a great investment, getting called during a bear market can wipe out your capital and you will never make it back - your asset allocation is forced onto you.

Thus it can make sense to borrow against a property & invest that money in stocks. Just make sure that you have a 10+ year time horizon to do this. Even 10 years it is not dead certain. And if property values fall at the same time, then you really can be in the mud.

The bottom line is that one shouldn't use leverage to buy stocks *unless* the term of that leverage loan is long. And you cannot be margin called in the meantime.

I am not sure about your tax rate gymnastics. In principle if interest is tax deductible then that can be a good way to invest -- that's what property investors do.
Topic Author
Digit
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Re: In a high-taxation country I should be gearing my investments, right?

Post by Digit »

Dear Valuethinker,

Thank you for your reply with interesting (and scary) numbers related to big crashes.

It seems I haven't managed to get my point through here.

The “tax rate gymnastics” are the core of my question. They are not an add-on. I do NOT intend to gear my investments to take on additional risk. Not at all. I intend to think of my tax as a way to keep volatility and risk at levels that are recommended in this forum.

Let’s say, as a resident of Denmark, I lose 100% of my capital in a sudden major crash. Then the Danish tax authorities will reimburse 42% of that loss through tax relief that year and the following years.

This means that I will NOT have lost everything. My risk will be exactly the same as if I were 67% in equities in a low-tax country where a loss is a 100% loss.

And there will be nobody forcing me to sell after a crash. Tax authorities will force me to sell after the good years, unfortunately, in order to pay my tax. But only after the good years.

I did NOT take on additional risk, according to the plan mentioned above. I kept the risk at exactly the same level. … At least, that’s the plan. Still curious to hear everyone’s response.

(In the case of my death, things will be different. If I die shortly after a major crash, yes, my inheritors will lose money, but that’ll be the least of my problems, I suppose.)
FinanceGeek
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Re: In a high-taxation country I should be gearing my investments, right?

Post by FinanceGeek »

A quick search led to the following link, which implies that mark-to-market does not apply to individual share holdings, only to funds. You might consider bailing on your current portfolio (since presumably that's tax free where you live now) and replace it with a well diversified portfolio of stocks and bonds.
While sale of ordinary shares is taxable based on a realisation principle, a so-called mark-to-market taxation is applied on bonds, investment funds, ETF, etc., which implies that each year taxable gain/loss is to be declared even though a sale has not actually occurred.
https://taxsummaries.pwc.com/denmark/in ... ermination

See also another post on this forum that discussed this very issue:
viewtopic.php?t=290510
MarkRoulo
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Re: In a high-taxation country I should be gearing my investments, right?

Post by MarkRoulo »

Digit wrote: Thu Jan 13, 2022 9:29 am ... snip ...

Let’s say, as a resident of Denmark, I lose 100% of my capital in a sudden major crash. Then the Danish tax authorities will reimburse 42% of that loss through tax relief that year and the following years.

This means that I will NOT have lost everything. My risk will be exactly the same as if I were 67% in equities in a low-tax country where a loss is a 100% loss.

... snip ...
Do you know how quickly this reimbursement happens? The US does something similar, but the "reimbursement" is capped at $3,000 per year so a $100,000 loss would take 33 years to get reimbursed (and this isn't inflation adjusted, of course).

Another poster has suggested just buying a reasonable mix of stocks directly. I'd probably look into that before I leveraged up.

You might even be able to find investments that are structured that way. There used to be these things called HOLDRs where you actually owned the underlying stock basket rather than owning shares in a fund that owned the stocks.

You also should probably talk with a Danish tax lawyer before you settle on a strategy ...
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Digit
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Re: In a high-taxation country I should be gearing my investments, right?

Post by Digit »

FinanceGeek wrote: Thu Jan 13, 2022 9:44 am A quick search led to the following link, which implies that mark-to-market does not apply to individual share holdings, only to funds. You might consider bailing on your current portfolio (since presumably that's tax free where you live now) and replace it with a well diversified portfolio of stocks and bonds.
While sale of ordinary shares is taxable based on a realisation principle, a so-called mark-to-market taxation is applied on bonds, investment funds, ETF, etc., which implies that each year taxable gain/loss is to be declared even though a sale has not actually occurred.
https://taxsummaries.pwc.com/denmark/in ... ermination

See also another post on this forum that discussed this very issue:
viewtopic.php?t=290510
Thank you, Finance Geek,

Yes, I might consider doing that. Danish capital gains tax laws are confusing.
If one owns individual Danish stocks, you can delay payment of increases in value until you sell the stock. The yearly dividend, however, is still taxed every year. A small selection of dividend-paying ETFs are accepted for the same taxation.

I was thinking of doing that. It seemed desirable. But then I thought “It’s all 42% no matter what I do. Why go out of the ETF that I like?”

When people strive for a delay of their tax payment until they sell the stock, in a way what they want is leverage. They want to invest money that they actually owe in tax. It seems the only way you can achieve long-term capital gains in Denmark.

But it’s leverage, that’s what they're after, and it’s a level of leverage that is decided by the markets and the tax authorities. Why not set that leverage yourself? And why not keep it consistently at a level the emulates the risk of a perfect Boglehead portfolio in a country without taxation?
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Digit
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Re: In a high-taxation country I should be gearing my investments, right?

Post by Digit »

MarkRoulo wrote: Thu Jan 13, 2022 11:47 am Do you know how quickly this reimbursement happens? The US does something similar, but the "reimbursement" is capped at $3,000 per year so a $100,000 loss would take 33 years to get reimbursed (and this isn't inflation adjusted, of course).

[...]

You also should probably talk with a Danish tax lawyer before you settle on a strategy ...

Uh oh, The US system sounds horrible. A cap on reimbursement changes everything. I’m under the impression that there is no cap on reimbursement in Denmark.

And yes, I should definitely check my facts with a Danish tax lawyer before making any pivotal decisions. Thank you for reminding me.

As I understand it, in Denmark, we have different rules for different types of stocks. (Just to make it even more confusing.) Some stocks will be approved for taxation by a special “stock tax”, others won't. Once the amount is above a minimal amount, it’s all taxed at 42% anyway.

I’ll be going for the investments that won't be approved for “stock tax”. Each year, all income from them will be added or deducted from my total income. And there’s no cap on the deduction, as far as I know. You’ll never experience the tax authorities giving you money in negative tax, but you can transfer the deficit to the following years. And you can do that indefinitely. That’s what a very experienced Danish tax lawyer told me. … But I’ll double-check.

You hear people say that it’s close to impossible to let capital grow in Denmark. But I’ve never heard anybody say that, actually, it reduces your risk enormously! And that that's an incredible advantage when utilized thoughtfully. You just need to emulate an untaxed Boglehead portfolio, using "inconsequential leverage" and the massive tax burden will be transformed into a surmountable yearly interest to be paid.

(... Or maybe not. I'm aware that I'm not the expert here.)
MarkRoulo
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Re: In a high-taxation country I should be gearing my investments, right?

Post by MarkRoulo »

Digit wrote: Thu Jan 13, 2022 12:34 pm
MarkRoulo wrote: Thu Jan 13, 2022 11:47 am Do you know how quickly this reimbursement happens? The US does something similar, but the "reimbursement" is capped at $3,000 per year so a $100,000 loss would take 33 years to get reimbursed (and this isn't inflation adjusted, of course).

[...]

You also should probably talk with a Danish tax lawyer before you settle on a strategy ...

Uh oh, The US system sounds horrible.
The US doesn't tax you until you sell, though.
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by Fat-Tailed Contagion »

Doesn't make sense to me.

Why would anyone willingly move to a high-tax country like Denmark?
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by prudent »

Subject: In a high-taxation country [Denmark] I should be gearing my investments, right?
Fat-Tailed Contagion wrote: Thu Jan 13, 2022 2:42 pm Doesn't make sense to me.

Why would anyone willingly move to a high-tax country like Denmark?
Doesn't matter. Let's stick to the OP's question.
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by Silly Wabbit »

Fat-Tailed Contagion wrote: Thu Jan 13, 2022 2:42 pm Doesn't make sense to me.

Why would anyone willingly move to a high-tax country like Denmark?
Seriously? Money ain't an end. Happiness. Family. Friends. Community. Loads of good reasons aside from money. It might even be a good deal money wise if one values the benefits provided.
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Fat-Tailed Contagion
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by Fat-Tailed Contagion »

I'm sorry if that triggered you, I was just trying to answer the question from OP on a Bogleheads investment forum as honestly as possible.
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by gougou »

Do you pay enough income taxes every year to fully realize the capital losses from a 50% crash in equities? If yes, then there’s no problem with your approach.

If you can’t get reimbursed immediately for all your losses, then the high tax is actually a risk to your portfolio, which means you need to be more conservative on your asset allocation.

Let’s think about it like a game. Head you win $110 tail you lose $100. You want to play this game with some of your money because you’ll win on average over the long term.

Now the government takes 42% of your winnings when you win, but it doesn’t reimburse your losses or it reimburses your losses very slowly over many years so the reimbursement isn’t worth 42% of your losses. Why would you ever want to be more aggressive with this game? At such a high tax rate I think I might just stop playing the game altogether.
finite_difference
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Re: In a high-taxation country I should be gearing my investments, right?

Post by finite_difference »

FinanceGeek wrote: Thu Jan 13, 2022 9:44 am A quick search led to the following link, which implies that mark-to-market does not apply to individual share holdings, only to funds. You might consider bailing on your current portfolio (since presumably that's tax free where you live now) and replace it with a well diversified portfolio of stocks and bonds.
While sale of ordinary shares is taxable based on a realisation principle, a so-called mark-to-market taxation is applied on bonds, investment funds, ETF, etc., which implies that each year taxable gain/loss is to be declared even though a sale has not actually occurred.
https://taxsummaries.pwc.com/denmark/in ... ermination

See also another post on this forum that discussed this very issue:
viewtopic.php?t=290510
While sale of ordinary shares is taxable based on a realisation principle, a so-called mark-to-market taxation is applied on bonds, investment funds, ETF, etc., which implies that each year taxable gain/loss is to be declared even though a sale has not actually occurred. The gain/loss is determined based on the market value at the start of the year compared to the value end of the year (values for start and end of the year will be changed to value upon arrival/departure if moving to/out of Denmark during the year). Value is to be converted to Danish kroner using the exchange rate at start of the year/end of the year, so this will cover both gain due to increase in value of the investment fund, etc. and gain due to currency fluctuations.

I’m trying to think through how this works. Let’s say we have 100 shares of SP500 ETF, each worth $1, so we have $100 invested. And every year for 10 years it goes up 10%. Gains are taxed as income at 42% rate each year. We sell shares to cover the tax, which is taxed as capital gains (maybe?) What’s the final balance?
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Valuethinker
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Re: In a high-taxation country I should be gearing my investments, right?

Post by Valuethinker »

Digit wrote: Thu Jan 13, 2022 9:29 am Dear Valuethinker,

Thank you for your reply with interesting (and scary) numbers related to big crashes.

It seems I haven't managed to get my point through here.

The “tax rate gymnastics” are the core of my question. They are not an add-on. I do NOT intend to gear my investments to take on additional risk. Not at all. I intend to think of my tax as a way to keep volatility and risk at levels that are recommended in this forum.

Let’s say, as a resident of Denmark, I lose 100% of my capital in a sudden major crash. Then the Danish tax authorities will reimburse 42% of that loss through tax relief that year and the following years.

This means that I will NOT have lost everything. My risk will be exactly the same as if I were 67% in equities in a low-tax country where a loss is a 100% loss.

And there will be nobody forcing me to sell after a crash. Tax authorities will force me to sell after the good years, unfortunately, in order to pay my tax. But only after the good years.

I did NOT take on additional risk, according to the plan mentioned above. I kept the risk at exactly the same level. … At least, that’s the plan. Still curious to hear everyone’s response.

(In the case of my death, things will be different. If I die shortly after a major crash, yes, my inheritors will lose money, but that’ll be the least of my problems, I suppose.)
Hello

Rereading what you posted I see I misinterpreted it.

The key, I think, is that you pay capital taxation without actually realising those gains or losses.

That makes this problem hard to analyse.

As long as you are confident that leverage does not work the way it would work normally. And that if stock returns are say 6-7% nominal you still come out ahead, then your strategy might work. Just don't make unrealistically high expectations of stock returns based on the recent past (European stocks went precisely nowhere from Jan 2000 to Jan 2010, I believe).
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by DJN »

Hi,
the payment annually of 42% of capital gains is "daylight robbery" of your invested earned and taxed income when it gains a little due to your prudence and must affect the incentive to save and invest for Danes.
You would be best advised to check out any pension schemes with tax incentives that already exist.
In addition you didn't mention your domicile and your current location. If you can, you should check the tax laws and regulations in Denmark if you really intend to move there and see if you for example you qualify for remittance taxation if you are not a Danish citizen? I have no clue about Danish tax laws.
You should also check if there are any securities that are not subject to the 42% capital gains rule.
Not sure why you would gear your investments and introduce more risk?
DJN
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fisher0815
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by fisher0815 »

I'm shocked about this taxation rules. In this case you have to create a DIY index fund:
https://www.bogleheads.org/wiki/Passive ... ual_stocks

https://www.investopedia.com/articles/s ... tfolio.asp
hithere
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by hithere »

I can't offer much help, but I've always asked myself how my investment strategy and finances in general would change if hypothetically I were to move to a higher-tax country. Given the 42% tax rate, what do the Danish people typically invest in? Are there any investment vehicles or strategies where the effective tax rate is lower than that?

Compared to the 0% tax I pay on my ETF and stock holdings, 42% is truly mind-blowing at first glance, because it seemingly changes everything with regards to retirement planning, but then we have to consider the context of living in a country like this where 1) much of the wealth makes its way to the bottom social classes and thus more people have a chance to save and invest, 2) some of your basic and not-so-basic needs are taken care of by the government and thus your living expenses are reduced, and 3) the social payments, including those during retirement, are quite good. So ultimately one might need to save less for retirement to achieve the same standard of living after they retire as someone from a lower-tax country. It's a lot more nuanced discussion than simply comparing the 42% to our countries' tax rates. Not to mention that those are nominal and not effective tax rates.
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Digit
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by Digit »

I’ve now checked with a top-notch Danish tax expert. I was right. In Denmark, all losses on capital income from foreign ETFs will be subtracted from one’s personal income when an individual’s tax is calculated.

If the total is negative, the taxpayer will not receive “negative tax” that year, but will be able to deduct the loss 100% from income in the following years.

It’s my view that with this system of taxation, one should take the amount of taxation into consideration when deciding on the best allocation of stocks vs. cash and bonds.

In short:

Allocating 100% of your capital to equities in Denmark (with 42% capital gains tax) will give you exactly the same risk, volatility, and potential gains as allocating 58% of your capital to equities in a capital gains tax-free country.

If you live in a country with e.g. 25% tax on capital gains, you can allocate 100% of your capital to equities, and it will give you the same risk profile as allocating 75% of your capital to equities in another country with zero capital gains tax.

It seems the level of taxation in one’s country should be part of the very first and very basic thoughts when deciding on asset allocation.

Very best,
Digit


PS. Yes, if you die shortly after a major stock market crash, your children will inherit less. And yes, you have to pay some interest if you choose to invest more than 100% of your capital in equities. And yes, you’ll have some fluctuations in liquidity over the years. But apart from those issues, adjusting your asset allocation could fully compensate for not living in a capital gains tax-free country. And because of the taxation, it can do so without adding any of the risk usually associated with a geared investment.
fisher0815
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by fisher0815 »

Digit wrote: Fri Jan 14, 2022 9:17 am In short:

Allocating 100% of your capital to equities in Denmark (with 42% capital gains tax) will give you exactly the same risk, volatility, and potential gains as allocating 58% of your capital to equities in a capital gains tax-free country.

If you live in a country with e.g. 25% tax on capital gains, you can allocate 100% of your capital to equities, and it will give you the same risk profile as allocating 75% of your capital to equities in another country with zero capital gains tax.
Can you help me understand it.
For example you're 100% invested in stocks and there is a 70% stock market crash, then you have just 30% of your money left in stocks and get booked a 70% tax loss, which you can deduct with future income. But what if there is no future income?

In the case the stock market goes sideways for 10 years and you have lost your job or are in retirement you will be out of money very fast. How can you say it has the same risk profile like 58% equities?
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Digit
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by Digit »

fisher0815 wrote: Fri Jan 14, 2022 10:25 am Can you help me understand it.
For example you're 100% invested in stocks and there is a 70% stock market crash, then you have just 30% of your money left in stocks and get booked a 70% tax loss, which you can deduct with future income. But what if there is no future income?

In the case the stock market goes sideways for 10 years and you have lost your job or are in retirement you will be out of money very fast. How can you say it has the same risk profile like 58% equities?
In this example, you're right! My calculation only works if you, during the following years, will earn a total income that is at least equivalent to your one-time loss.

That is, your combined income from work, pensions, rising stock values, AND DIVIDENDS in your portfolio must exceed that single loss.

In your example, if you have zero income and you need the money within the next ten years then you're wrong to be 58% in stocks, in the first place. So part of this fictional investor’s financial catastrophe isn't my calculation, it’s the poor sod’s starting point.

You're also right that a major stock crash WILL happen, at some point in our lifetime. It regularly does, we just don’t know when.

But usually, most of the lost value will regrow within the foreseeable future. A 70% crash that is followed by zero gains for 10 years, I don’t think that has ever happened. And even if it did, there’d still be the dividends, which would be tax-free for you. Has the global index PLUS DIVIDENDS ever been seriously lower than ten years before?

Thank you for engaging in my contemplations.
fisher0815
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by fisher0815 »

Ok, thanks. But keep in mind, holding 100% or more than 100% in stocks comes with danger, because of behavioral pitfalls. Here is a better example of a horrible stock market crash and how it feels like:
viewtopic.php?p=4726190#p4726190

Maybe if you are young and have not accumulated much net worth compared to your future income, then it can work. But your net worth will grow over time and then the amount of loss from a stock market crash will get bigger and bigger and that's not easy to handle.

If I would live in Denmark, I would sell my ETF/Funds and would buy the Top 50-100 stocks of the S&P 500 and then check every year for new entrants/removals to the Top 50/100 to buy/sell. If you are in the accumulation phase just buy new entrants with new money and don't sell removals. The tracking error to the broader S&P 500 would be marginal. Turnover rate would be very low (around 4% per year) and the compounding effect is with you, because your individual stocks will not taxed until you sell.
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Re: In a high-taxation country [Denmark] I should be gearing my investments, right?

Post by mexpat »

Hi Digit,

With the caveat that I have not lived in Denmark for a very long time, I am not sure your assumption on how the capital income tax works is correct i.e. 42 % of unrealized gains/losses each year.

For shares bought on a regulated market which is most formal stock markets in todays world, your capital gains are only due when you sell the stocks, not every year. It used to be that if you held stocks on a non-Danish stock market you paid yearly tax of gains as you outline, but that is no longer the case as I understand it.

A modest amount (some 15k/person) you can put in an 'Aktiesparekonto' where the annual tax on gains is 17%.

I think you need to consult with the tax authorities or get expert advice on how the 42% tax works as it could be quite different from what you outline.
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