How to replicate an index tracker with individal stocks

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downforwardone
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How to replicate an index tracker with individal stocks

Post by downforwardone » Tue Jan 14, 2020 3:46 pm

Hi,

I'm in the unfortunate position of being a US citizen in the UK, wishing to invest my ISA in a world index tracker. As some of you will know that's currently all but impossible. I've read some posts here of people in similar positions and the best option I can see right now is to replicate an index tracker by buying individual stocks. I read this fantastic article https://www.bogleheads.org/wiki/Passive ... _stocks.3F but I would love to hear some more thoughts on the "How to choose stocks?" section.

My best idea right now is to open an ISA on Trading212 (for the zero trading fees), and attempt to buy stocks in the same ratio that they exist in a world index tracker, starting I suppose with the top 20 or 30 largest stocks. Each month when I add money I would attempt to add the next few biggest stocks, and rebalance existing stocks where needed.

Questions:
1) Is there an up to date handy resource that shows the worlds stocks in the ratios they exist in? For example, a list of all the stocks by market cap size in the MSCI All Country World Index, or a list of the stocks that the Vanguard FTSE global all-cap holds? I can only find their top 5.

2) Is this a reasonble thing to attempt? Or should I just pick a sprinkling of 30 or so hopefully representative stocks and leave it

3) Does anyone have any experiences or wisdom to share of doing something similar.

Thank you very much for your help

df1

Schlabba
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Re: How to replicate an index tracker with individal stocks

Post by Schlabba » Tue Jan 14, 2020 4:13 pm

downforwardone wrote:
Tue Jan 14, 2020 3:46 pm
Questions:
1) Is there an up to date handy resource that shows the worlds stocks in the ratios they exist in? For example, a list of all the stocks by market cap size in the MSCI All Country World Index, or a list of the stocks that the Vanguard FTSE global all-cap holds? I can only find their top 5.
https://www.ishares.com/uk/individual/e ... -ucits-etf at the "Holdings" section you can click on "All".
downforwardone wrote:
Tue Jan 14, 2020 3:46 pm
2) Is this a reasonble thing to attempt? Or should I just pick a sprinkling of 30 or so hopefully representative stocks and leave it
I would also start at the top of the list. Because those shares are the largest in the index, they represent the "biggest bang for your buck" in terms of approximating the index.
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

Topic Author
downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Tue Jan 14, 2020 4:39 pm

Perfect, thank you so much for the link. It feels much more achievable now.

Good point about thinking about it in terms of how much of the index I'm replicating with each purchase.

TedSwippet
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Re: How to replicate an index tracker with individal stocks

Post by TedSwippet » Tue Jan 14, 2020 7:10 pm

downforwardone wrote:
Tue Jan 14, 2020 3:46 pm
My best idea right now is to open an ISA on Trading212 (for the zero trading fees), and attempt to buy stocks in the same ratio that they exist in a world index tracker, ...
Thanks to FATCA, quite a few UK brokers and platforms now refuse to open accounts for US persons. Before you plan too much further, maybe confirm with Trading212 that they are happy to accept US citizens as customers.

Their web site doesn't seem to specifically exclude US persons, but they do say in their T&Cs that they will require a completed W-8BEN before they will allow clients to trade US stocks. As a US citizen, you can't (legally, validly) complete a W-8BEN.

rich126
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Re: How to replicate an index tracker with individal stocks

Post by rich126 » Tue Jan 14, 2020 7:17 pm

So you can buy individual stocks but not ETFs, closed ended funds, etc.?

Personally I might just buy Berkshire Hathaway (BRK.B) and that would be good enough for me. You don't have to worry about any taxes on dividends since they don't pay one.

Topic Author
downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Tue Jan 14, 2020 9:42 pm

That's correct, no ETFs etc.

It will be in a UK ISA so won't be any tax on dividends. I'll look into BRK.B anyhow, thank you.

TedSwippet, I wasn't aware of that, thanks for mentioning it. I'll check it out. Every time I think I've found a sort of solution another road block appears. It seems more and more like it's just an impossible situation.
Last edited by downforwardone on Tue Jan 14, 2020 9:50 pm, edited 1 time in total.

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timboktoo
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Re: How to replicate an index tracker with individal stocks

Post by timboktoo » Tue Jan 14, 2020 9:50 pm

Though Berkshire Hathaway is an excellent company, it would be very risky to invest much of your wealth in a single stock.

You might benefit by searching the archives.

- Tim

Slowtraveler
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Re: How to replicate an index tracker with individal stocks

Post by Slowtraveler » Tue Jan 14, 2020 10:01 pm

In Bogle's "Common Sense on Mutual Funds", he recommends to create a private index for those seeking tax efficiency over buying a mutual fund index fund. He recommended to buy the 50 largest (by market cap) stocks in equal weight and make no subsequent changes. Including taxes, the advantages would be significant. I am paraphrasing but the idea is the same. Read it for yourself and please report back if you do apply it. I'd be fascinated in the results.

The section begins on page 387 under the section titled: "A Better Solution: The Tax-Managed Fund".

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Re: How to replicate an index tracker with individal stocks

Post by TedSwippet » Wed Jan 15, 2020 3:35 am

downforwardone wrote:
Tue Jan 14, 2020 9:42 pm
It will be in a UK ISA so won't be any tax on dividends. ...
No UK tax, but for you as a US citizen, any dividends and capital gains remain subject to US tax. I'm pretty sure you know this; I'm just mentioning it for the benefit of any other readers. More in this wiki page:

US tax pitfalls for a US person living abroad - Bogleheads

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downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Wed Jan 15, 2020 8:25 am

Quite right TedSwippet. I hope not be selling any portion of this portfolio until I'm retired, in which case I would fall into the long term 0% capital gains bracket, unless I'm misunderstanding something. Dividends the US would treat as income though.

It's a minefield.

Valuethinker
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Re: How to replicate an index tracker with individal stocks

Post by Valuethinker » Wed Jan 15, 2020 8:39 am

downforwardone wrote:
Tue Jan 14, 2020 4:39 pm
Perfect, thank you so much for the link. It feels much more achievable now.

Good point about thinking about it in terms of how much of the index I'm replicating with each purchase.
Use stratified sampling. The approach in effect the Dow Jones Industrial Average uses - leading companies in different sectors (but they can expel a company & replace it cost free, which you cannot do).

You don't need *all* Oil & Gas companies, just 1 or 2. Depending on how dividend tax withholding works you might want to own Exxon + Royal Dutch Shell for example. If I was a betting man I would probably own something like Exxon + EOG (saved from the wreckage of Enron, with a very good management team and disciplined approach to fracking). You get the biggest best of the old line oil companies and the best of the new boys.

Mining companies you could own BHP Billiton and leave it at that (or that + Rio Tinto).

Retailers? For sure I'd own Zara (Inditex). How many others? WalMart also. Not sure if Aldi or Lidl are quoted (and there are 2 Aldis). If I own Inditex + WalMart + one of the German food discounters (+ Amazon, despite reservations below) do I need to own many other retailers?

Tech is different because the companies are very different in their performance. You probably do need Apple Microsoft Alphabet Amazon. It's the 4th one in that list that tends to give me pause. Also I debate Facebook with myself. My own view is we are in that late market mania phase (almost) where it just pays to blindly buy the hottest stocks whose market capitalisations have been driven to the highest point - and that means the FAANGS + Microsoft. This may not end well - so you do not need to own full market weight.

Cars? I'd own BMW if anything. Not sure what else I might own.

Banks? OK you own JP Morgan. Maybe you don't need HSBC. You probably don't need too many other non-USA banks.

Pharma, again, you probably need to own several because they each rise and fall on different drug prospects & strategies. A bit like tech.

Berkshire Hathaway is itself a conglomerate (Insurance, holdings in financial services companies like Amex, railways, utilities).

EDIT - most of the "advice" below is useless, see Ted Swippet's post

There *are* UK investment trusts. Be careful here, because they themselves may trigger PFIC. Otherwise you can proxy Private Equity quite nicely using them. Not just 3i but but things like Graphite. If you cannot hold those (PFIC) then Intermediate Capital Group (fund manager covering lending to PE deals - will be very high beta stock).

Take a look at what is inside the Lindsell-Train investment trust. There are some very good ideas in there in terms of long term good users of shareholders' capital.

[deleted references to Investor AB the Wallenberg family vehicle; also Asset Value Investors investment trust. Swire Group in HK might still be an idea - China play]


I don't know if there are any free modelling programmes out there that can calculate tracking risk for you ie the chances of being within a set distance of index performance with a self constructed portfolio. Worth looking around.

Beware in the UK market there is a "crowded trade". It's around income stocks held by income funds that investors have piled into in replacement for - the majority of the total dividends paid by UK companies are paid by a handful of stocks. Royal Dutch Shell is one of them (but so huge that this might not matter - UK investors won't be the majority of holders). But also the tobacco stocks. You want to be careful of joining in that crowded trade because if the market turns against it say due to rising interest rates, it can hurt.
Last edited by Valuethinker on Wed Jan 15, 2020 10:09 am, edited 2 times in total.

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Re: How to replicate an index tracker with individal stocks

Post by TedSwippet » Wed Jan 15, 2020 8:59 am

Valuethinker wrote:
Wed Jan 15, 2020 8:39 am
There *are* UK investment trusts. Be careful here, because they themselves may trigger PFIC.
It is almost certain that UK investment trusts are PFICs.
Valuethinker wrote:
Wed Jan 15, 2020 8:39 am
Asset Value Investors has a lot of holding companies such as the Wallenberg ones in Sweden (Investor) and that's another way of getting index exposure without owning so many names - own Investor & own the Swedish index.
Investor AB is also very likely to be a PFIC. The definition of a PFIC is extremely broad:
Under the U.S. Code, the term “passive foreign investment company” means any foreign corporation if—
  • 75 percent or more of the gross income of such corporation for the taxable year is passive income, or
  • the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.
In practice, this definition captures nearly all local funds and ETFs used by investors in countries other than the US. This makes these funds a potential tax trap for US citizens living abroad, and also for non-US citizens living temporarily in the US.

Valuethinker
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Re: How to replicate an index tracker with individal stocks

Post by Valuethinker » Wed Jan 15, 2020 10:02 am

TedSwippet wrote:
Wed Jan 15, 2020 8:59 am
Valuethinker wrote:
Wed Jan 15, 2020 8:39 am
There *are* UK investment trusts. Be careful here, because they themselves may trigger PFIC.
It is almost certain that UK investment trusts are PFICs.
Valuethinker wrote:
Wed Jan 15, 2020 8:39 am
Asset Value Investors has a lot of holding companies such as the Wallenberg ones in Sweden (Investor) and that's another way of getting index exposure without owning so many names - own Investor & own the Swedish index.
Investor AB is also very likely to be a PFIC. The definition of a PFIC is extremely broad:
Under the U.S. Code, the term “passive foreign investment company” means any foreign corporation if—
  • 75 percent or more of the gross income of such corporation for the taxable year is passive income, or
  • the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.
In practice, this definition captures nearly all local funds and ETFs used by investors in countries other than the US. This makes these funds a potential tax trap for US citizens living abroad, and also for non-US citizens living temporarily in the US.
Thank you.

Kicks that into the long grass ....

Department of bad ideas from valuethinker, number 7 hundred and fifty something ...

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Re: How to replicate an index tracker with individal stocks

Post by Valuethinker » Wed Jan 15, 2020 10:16 am

Slowtraveler wrote:
Tue Jan 14, 2020 10:01 pm
In Bogle's "Common Sense on Mutual Funds", he recommends to create a private index for those seeking tax efficiency over buying a mutual fund index fund. He recommended to buy the 50 largest (by market cap) stocks in equal weight and make no subsequent changes. Including taxes, the advantages would be significant. I am paraphrasing but the idea is the same. Read it for yourself and please report back if you do apply it. I'd be fascinated in the results.

The section begins on page 387 under the section titled: "A Better Solution: The Tax-Managed Fund".
i remember this well.

My sense is in the long run you did well, or about as well as the market as a whole (in the sense that the Dow 30 tends to track the S&P 500 long run) *but*:

- if you buy the Nifty Fifty just when that style of investing fades, it's going to really hurt. In many ways with the FAANGs we are as close to the 50 as we have ever been (you could argue about 1999)

- you have to have some rule that lets you buy emerging superstars. Problem: they were once Yahoo, AOL Time Warner etc. It wasn't obvious in 2000 that Cisco would not be a leader and Amazon & Apple would. But as stocks rise into that top 50 in world market cap, you have to have some rule whether you include them or not. Tesla might well be a blip (it has all the financial characteristics of your classic torpedo stock; a serious disappointment will also lead to a downward valuation multiple compression). But there will be others that won't be

It's worth remembering that, AFAIK, Microsoft has never raised new equity from external investors *except* one Venture Capital deal (where the guy spent 7 years wooing Bill Gates to sell him a 5% stake). Google has not since flotation. Some business models are just very robust. By contrast the cellular companies were built on huge, successive, capital raisings.

Slowtraveler
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Re: How to replicate an index tracker with individal stocks

Post by Slowtraveler » Wed Jan 15, 2020 11:05 am

@ValueThinker

Bogle actually addressed this a few pages later (390) in the same chapter. He discusses research by Jeremy Siegel showing how the Nifty Fifty outpaced the S&P500 by .7% buying near the peak in 1971 for a 25 year period.

I actually want to index like this for the tax efficiency. Just waiting to harvest a capital loss and definitely keep some in regular total stock index to compare/ have easy access. It's much less convenient accessing funds so it'd be something to buy and hold while selling the fund version if capital is needed and all my bonds, etc, have been used up.

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downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Wed Jan 15, 2020 12:05 pm

Thank you all for your input.

Another thought has crossed my mind. My UK wife has no links to USA at all. Of course we are currently using her ISA allowance each year to happily invest in a world index tracker. And I'm trying to replicate that with individual stocks because of my US citizenship.

However, TedSwippet's observation that me using a UK broker to trade US stocks might not be a goer because of the W-8BEN requirement, has got me thinking.

Why not have my wife invest in just a US index tracker in her ISA, and then I invest in purely non-US individual stocks in my ISA, replicating an ex-US fund like this https://www.ishares.com/us/products/239 ... -ex-us-etf Between the two of us we'd have an almost perfect coverage of world equities, and would avoid the W-8BEN issue.

Does that seem reasonable?

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Re: How to replicate an index tracker with individal stocks

Post by TedSwippet » Wed Jan 15, 2020 12:57 pm

downforwardone wrote:
Wed Jan 15, 2020 12:05 pm
Between the two of us we'd have an almost perfect coverage of world equities, and would avoid the W-8BEN issue.
Have you tried creating an account with Trading212 yet, or confirmed with them that you can? There's probably a point in their 'onboarding' process where they ask if you are 'tax resident' in countries besides where you currently live, in this case UK. If you say yes and give US as the other country, this is where many 'onboarding' processes will reject you.

Although Trading212 do not say explicitly that they do not accept US citizens, I found this suggestion that they do not:
... Trading 212 does not provided services to US citizens, to any under the age of 18 years or without prior checks.

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downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Wed Jan 15, 2020 1:57 pm

Not yet, but I think I was getting a bit ahead of myself by picking a broker already. I hope there's at least one that submitted to dealing with Fatca rather than just blankly refusing US citizens.

If not I'm out of luck and this is all moot. I'd have to just have my wife do all the investing and accept that my ISA allowance will only ever be used for cash.

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Re: How to replicate an index tracker with individal stocks

Post by aj76er » Wed Jan 15, 2020 4:06 pm

If I was in this situation, I would probably just check the top 30 holdings of Vanguards total world ETF, VT, And buy those stocks in equal weight percentages. Here’s the list, right from Vanguards page for VT:

https://investor.vanguard.com/etf/profi ... o-holdings

Update and Rebalance on any reasonable time-table (annually, quarterly, etc). Easy peasy :).
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

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Re: How to replicate an index tracker with individal stocks

Post by plasticfork » Wed Jan 15, 2020 6:04 pm

I'm just going to hijack OP's thread because I'm in a similar situation. I hope that's okay.

If one, based in France, were to do this would it be more advantageous to do it with a US Broker (such as Interactive Brokers) or invest through a local "PEA" securities account ?

Valuethinker
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Re: How to replicate an index tracker with individal stocks

Post by Valuethinker » Thu Jan 16, 2020 3:47 am

aj76er wrote:
Wed Jan 15, 2020 4:06 pm
If I was in this situation, I would probably just check the top 30 holdings of Vanguards total world ETF, VT, And buy those stocks in equal weight percentages. Here’s the list, right from Vanguards page for VT:

https://investor.vanguard.com/etf/profi ... o-holdings

Update and Rebalance on any reasonable time-table (annually, quarterly, etc). Easy peasy :).
WIth a degree of stratified sampling.

You might hold 1-2 banks for example. Ditto energy stocks (hold Exxon). Berkshire Hathaway itself gives you quite a bit of financial services exposure (insurance but also Amex, Wells Fargo).

There are other sectors where the differentiation in share performance is greater due to the nature of the businesses. I am thinking technology and health care in particular. Also industrials & retail.

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downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Thu Jan 16, 2020 11:04 am

Update for anyone following this, it doesn't work.

I can't buy US shares in a UK ISA, for precisely the reason TedSwippet mentioned. To buy US shares a UK broker requires me to fill out a W-8BEN form which a US citizen can't do. It's literally to certify that you aren't a US citizen. So that's more than half the world index I already can't touch even if I find a broker that let's me sign up.

In addition, I've not yet found a low trading fee broker that lets me purchase individual shares in Japanese, Canadian and Chinese companies, which leaves me with just UK and the rest of Europe. A grand total of about 16% of the world market. Not such a great world index tracker!

Options now
1) I could try really hard to convince myself that investing my ISA allowance in just the UK and Europe is a good idea (maybe an enormous home bias is a good thing!.... :( )
2) Just have my wife do all our investing. It won't all be in an ISA but if we keep on top of harvesting capital gains allowance hopefully we can minimise the tax. My ISA allowance will be doomed to be unused.
3) A bit of both. I replicate the UK and Europe market and my wife index tracks the rest of the world. We'd have to choose between having a very unbalanced portfolio or only use a small amount of my ISA allowance.

Unless some laws change I don't see any way round it. (I can't directly invest in USA in case anyone is wondering. I've never lived there and don't have residency, which every US broker seems to demand. Even if I could it wouldn't be in an ISA so is no better than just having my wife invest it from here outside of her ISA)

Thanks again for everyone's responses, it has been helpful.

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Re: How to replicate an index tracker with individal stocks

Post by TedSwippet » Thu Jan 16, 2020 1:42 pm

downforwardone wrote:
Thu Jan 16, 2020 11:04 am
I can't buy US shares in a UK ISA, for precisely the reason TedSwippet mentioned. To buy US shares a UK broker requires me to fill out a W-8BEN form which a US citizen can't do. It's literally to certify that you aren't a US citizen. So that's more than half the world index I already can't touch even if I find a broker that let's me sign up.
Frustrating. I might have suggested writing to your congressperson to try to get leverage on changing these ludicrous US tax laws for US citizens living abroad. But congress has been made well aware of the issues for over a decade, since FATCA passed (if not long before even that), and has chosen to do nothing. Except perhaps to make things incrementally worse for some people, with the TCJA in 2017.
downforwardone wrote:
Thu Jan 16, 2020 11:04 am
3) A bit of both. I replicate the UK and Europe market and my wife index tracks the rest of the world. We'd have to choose between having a very unbalanced portfolio or only use a small amount of my ISA allowance.
Of your options, I would look closest at this one. There's no reason to have an unbalanced portfolio. Your wife can invest in both the UK/Europe and the rest of the world, just with more held in non-UK/Europe to allow for whatever part of the allocation it is that you hold in your ISA. She can dial back her UK/Europe holdings as you build up yours.

As a further thought, does an ISA really buy you that much? It's a handy UK tax shelter, but since the US ignores the ISA wrapper and so will take in tax what the UK does not, how far ahead does that get you relative to a plain unwrapped trading account? If not that far -- or if you cannot find a UK broker willing to open an ISA account for US citizens -- you could open an unwrapped trading account with Interactive Brokers and then buy and hold stocks from the US, UK, Europe or wherever with relative ease. That might beat having your wife invest this for you instead outside an ISA, not least because you'd have double the UK allowances on dividends and capital gains (see next paragraph), maybe not useful now, but potentially very useful in future as your investments grow.

The main loss here would be an unused annual ISA allowance, something you cannot make up later, but unless you plan to renounce your US citizenship an ISA is likely to be no more use to you in future than it is now. Remember that the UK allows you £12k/year in tax-free capital gains and around £2k/year or so in tax-free dividends even outside an ISA, so below around £60k or so a carefully managed unwrapped account may be no worse UK-tax-wise than an ISA.
downforwardone wrote:
Thu Jan 16, 2020 11:04 am
Thanks again for everyone's responses, it has been helpful.
Sorry the outcome isn't more positive. The US makes life very difficult for its citizens if they move abroad; this nonsense is a prime example of why I did not naturalise US citizenship when I had the chance (no regrets). One cannot help but wonder if part of this is deliberate policy, perhaps as a way to discourage folk from leaving the plantation. The IRS Taxpayer Advocate Service regularly calls out all of the problems that US tax causes for these people, and congress and the IRS just as regularly ignore them.

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downforwardone
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Re: How to replicate an index tracker with individal stocks

Post by downforwardone » Thu Jan 16, 2020 2:52 pm

TedSwippet that's a really, really helpful post, thank you. It's wonderful to have someone fully understand my situation (even more than I do myself). Very good point about the value of an ISA.

I will have a good long think and make sure I've fully digested the info here. I'll try and update this thread once I have my plan finalised assuming it works out just in case anyone in a similar situation stumbles across it and is wondering how I got on.

Thanks again.

ksomarket
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Re: How to replicate an index tracker with individal stocks

Post by ksomarket » Thu Jan 23, 2020 5:20 pm

downforwardone wrote:
Thu Jan 16, 2020 2:52 pm
TedSwippet that's a really, really helpful post, thank you. It's wonderful to have someone fully understand my situation (even more than I do myself). Very good point about the value of an ISA.

I will have a good long think and make sure I've fully digested the info here. I'll try and update this thread once I have my plan finalised assuming it works out just in case anyone in a similar situation stumbles across it and is wondering how I got on.

Thanks again.
Have you tried Hargreaves Lansdown? I'm in the same situation as you (US/UK dual citizen living in the UK) and had no problem setting up an ISA as a US person there last year. With a good income and a lot of carryover tax credits I think the benefits can definitely be worth it.

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