Jan. 11, 2022

U.S. mutual fund providers have been limiting fund access, while U.S. custodians are shutting non-resident U.S. expat accounts due to the regulations surrounding the Foreign Account Tax Compliance Act (FATCA).

Those that are afflicted are frequently frustrated and puzzled as a result. Considering the greater developments in cross-border taxation and compliance, the disruption may frequently provide an opportunity for expats to evaluate their investment plan options and adviser relationships.

This new setting might be overwhelming at times. However, the development of other financial products such as Exchange Traded Funds (ETFs) may provide for alternative solutions for U.S. expat investment options, depending on their objectives and investment strategy. 

Proper selection of appropriate ETF strategies may also address some challenges in investment allocation planning and compliance issues for U.S. expats living abroad.

What is an Exchange Traded Fund (ETF)?

An ETF is comparable to a mutual fund as it allows a U.S. expat to invest in a diversified range of equities or bonds in a single exchange. However, unlike mutual funds, ETFs are traded on an exchange, and their values fluctuate throughout the day, like an individual stock.

The holdings of an ETF are often linked to the composition of an index, such as the S&P 500 Index (US major capitalization stocks), the Barclays Aggregate Bond Index (US bonds), or the MSCI Europe Index (European stocks) to name a few.

Mutual funds, on the other hand, invest in a pool of securities that are hand-picked by managers of the fund. As a result, the structure of ETFs tend to provide significant efficiencies over mutual funds.

Why do U.S. Expats Invest in ETFs?

Most financial consultants advocate diversification, but the fact is that most portfolios are unbalanced, with too much stock (or too many bonds), too much cash, or too much in US domestic securities. Pooled investments like mutual funds, REITs and ETFs may greatly boost diversity since they allow access to a wide range of investment types across global markets.

Although most U.S. mutual funds shy away from non-U.S. residents, due to limitations from FATCA compliance issues, ETFs don’t have the same restrictions.  ETFs also offer exposure to worldwide equities, bonds, and other investments such as global commodities and real estate.

Expats should strive for global diversification for planning purposes. US expats routinely move occupations and countries of residency. As a result, they are exposed to various jurisdictions and currencies.

One significant aspect of cross-border currency planning is to keep some money for future costs in the same currency as those expenses. However, because many Americans are unclear of where they will be in several years, they need a globally diversified portfolio with exposure to a variety of currencies.

Thanks to a wide range of ETFs available in the market, investors may easily and accurately diversify their portfolio in terms of region and currency.

Cost and Tax efficiency of ETFs:

Taxes and management fees are some of the greatest expenses that can easily diminish your returns.  Aside from your ability to diversify within ETFs strategies, proper ETF portfolio management may also help lower tax and management expenses as follows:

• Tax Efficiency: Due to the low yearly turnover of ETFs, taxable distributions are restricted to dividends and interest, while capital gains are not realized, and capital gains tax is delayed. This enables the investors to determine the timing of capital gain realization, allowing them to manage tax responsibilities in a more convenient manner.
• Cost Efficiency: ETFs imitate the holdings of their comparable indexes without the need for a costly management team. Unlike mutual funds, the underlying index in ETFs do not change frequently, thereby reducing turnover, management and trading costs associated with pooled investments.
• Global Tax Efficiency: ETFs can often avoid cross-border investment pitfalls that many Americans overseas encounter, in addition to being able to regulate the realization of capital gains. While mutual funds are susceptible to punitive taxes as foreign investments, ETFs may be considered for optimum tax treatment since they are traded on an exchange. 

Many investors know the key benefits of exchange-traded funds (ETFs): lower costs, trading flexibility, transparency and tax efficiency. But not too many people are aware that ETFs may also help reduce tax bills through a strategy called tax-loss harvesting. It’s a strategy with taxable accounts that can be employed throughout the year—and useful whenever volatility strikes—to sell losing positions to offset capital gains.

Fluctuations in the market can be an opportunity to reassess your portfolio. Although investment losses can be hard to swallow, tax-loss harvesting lets you take the losses of one investment to offset the gains of another. By capitalizing on losses, you may sometimes offset future gains while giving you the ability to rebalance your portfolio. Taxes alone should not drive investment decisions. But harvesting losses made in concert with an overall investment plan may ease the future tax-bill sting.

It is important to be mindful of specific rules around tax-loss harvesting when it comes to choosing a replacement for securities sold at a loss. The IRS prohibits a wash sale, which is buying a substantially identical security within 30 days before or after selling a security at a loss.

Conclusion

Changing one’s financial plan, like many other aspects of living abroad, may be an opportunity disguised as a problem (provided Americans avoid the major mistakes made by expats abroad). The structure and efficiency of ETFs may offer solutions to investment, tax and regulatory issues confronting Americans overseas.

Most importantly, ETFs are only one strategic component of financial planning and investment management U.S. expats should use in conjunction with a holistic financial planning strategy (long-term wealth, estate, retirement, and tax planning) to fully transform the challenges into an opportunity, as you develop a secure financial future anywhere in the world.

Disclaimers:

This information is for educational purposes only and is not intended as investment or tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual tax situation.

Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions and fees may reduce returns.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.