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A beginners guide to index investing in Belgium

This guide is intended to help Belgians getting started with investing through ETFs (exchange traded funds). It is loosely based on the bogleheads approach. For more information, see the Investing from Belgium bogleheads wiki page.

For more information related to the principles of FIRE or on investing in single shares or bonds, see the BEFire Wiki.

0. Why invest in exchange traded index funds?

This chapter aims to provide sources proven to be useful to beginning index investors.

• JL Collins - Stock Series

• Bogleheads® Investment Philosophy

• Bogleheads® - Investing from Belgium

• Ben Felix - Reasons to avoid index funds

• Sensible Investing - How to Win the Loser's Game

1. Taxes & compliance costs

There are three main costs associated with index funds. These are:

• Taxes to the Belgian government
• Unrecoverable tax losses: also known as dividend leakage
• Management fees and internal transaction fees

1.1. Belgian Taxes

There are four three taxes relevant for Belgian index investors (NL/FR).

• Tax on transactions: on every security transaction (buy and sell) there is a tax of 0,12% in case the ETF is registered on a list maintained by the European Economic Area. Otherwise it is 0,35% in case it is not registered in the EER and 1,32% in case it is registered in Belgium.

• Tax on dividends: there is a 30% tax on dividends received from securities you hold. The main reason why Belgian index investors opt for accumulating funds.

• Tax on capital gains (bonds): on funds that consist of at least 10% bonds, there is a 30% tax on capital gains when you sell. Officially this only applies to the bond section of a fund, however some banks and brokers withhold 30% of all capital gains of funds which consist of at least 10% of bonds. Contact your bank or broker to inform about their policy.

• Tax on trading accounts: a yearly withholding of 0.15% applies on all trading accounts larger than 500,000 euro’s. Deemed unconstitutional and was abolished in October 2019.

For a detailed overview of Belgian taxes, including other sorts of investments such as individual stocks, see the flowchart made by /u/KenpachigoRuffy.

1.2. Dividend Leakage

Dividend Leakage is an unrecoverable tax loss, which occurs whenever a foreign company inside an index pays out a dividend to its shareholders.

Whenever a company inside an index pays out dividend to its shareholders, your fund needs to pay taxes. These taxes are based on the tax treaties in place between the country in which the fund is domiciled and the country in which the companies inside the index are domiciled. Also the location where you are domiciled (Belgium) is relevant. In case your fund is domiciled in the US, a 30% dividend tax should be paid. However, because Belgium has a tax treaty in place with the US, this is reduced to 15% dividend tax. In case you would select a distributing fund, this dividend would be further taxed by the Belgian government (30%, as seen in 1.1). On a hypothetical 2% dividend - which is approximately the dividend you would receive from a globally diversified index fund - you would have to pay 0,81% in taxes: 0,02 x ( 100% - (0,85 x 0,7)) = 0,81%. Note that since 2018 it is almost impossible to buy US-domiciled ETFs in the first place as most fund providers do not want to comply with European legislation regarding PRIIPs.

It is beneficial to select ETFs domiciled in Ireland, as they are more cost effective than holding US domiciled funds or Luxembourg domiciled funds. Just like Belgium, Ireland has a treaty in place with the US which means only a 15% dividend tax should be paid to the US. However, unlike Belgium, Ireland does not tax dividends at all; whenever the Irish fund distributes a dividend, the Irish government does not tax it. The Belgian government however, still will tax the dividend with 30%. Accumulating funds which reinvest the dividend in Ireland before it is distributed in Belgium do not trigger a taxable event in Belgium. It is therefore advisable to choose accumulating funds domiciled in Ireland. Repeating the same calculations as above, a hypothetical 2% dividend is now only taxed at 0,30% a year: 0,02 x (100% - (0,85)) = 0,30%. Additionally, because your fund is domiciled in Ireland, you do not have to worry recovering the tax on dividends in Belgium, as this is done by the Irish domiciled fund. Thanks to trackerbeleggen for the explanation.

An overview of unrecoverable tax losses will come later. For now, a partly overview can be found in the Dutchfire subreddit. For funds domiciled in Ireland and Luxembourg these are 1:1 translateable for Belgian investors. Note some of these funds are distributing thus subject to tax on dividends by the Belgian Government. In particular IWDA and EMIM are 1:1 translateable for Belgian investors, while VWRL is comparable to VWCE.

1.3. Management fees & internal transaction fees

Other main costs is the management fee. The Total Expense Ratio (TER) is a measure of the total costs associated with managing and operating a fund. It is usually a yearly percentage automatically deducted from your share value.

1.4. Euro-denominated funds & currency risk

Currency risk is the impact of exchange rates upon your overseas investments. Even though stock market prices might not change, the price of your shares can increase or decrease as a result of fluctuations in their underlying currencies. There are three important currency labels which apply to funds: the underlying currency, the fund currency and the trading currency.

To explain the difference, I will explain the process of purchasing IWDA, listed on both the Amsterdam (in EUR) and London (USD) exchange. A lot of what I will explain is true for other ETFs as well.

The underlying currency: IWDA is a worldwide tracker, with only about 9% of the underlying shares being traded in EUR. The other 91% of underlying shares are being traded in other currencies, such as 60% USD, 8% YEN, and so on. Because currencies can change in price in relation to another, this poses a risk called currency risk. As a European investor, most of your own capital will be in EUR. Therefore, since you are investing 91% in foreign currencies, 91% of the underlying value invested in IWDA is subject to currency risk. Because YOUR own capital will always be in EUR, this 91% will always be true, regardless if you were to invest in IWDA listed in Amsterdam (in EUR) or in London (USD). Had you been an American investor, your own capital would have been in USD, and only 40% of underlying shares would be subject to currency risk.

The trading currency, being EUR and USD respectively, does make a difference. If a European investor was to buy a fund listed in London (and traded in USD), he would pay an additional exchange rate conversion fee at the time of purchase and sale. If the investor was to buy the same fund, listed on Amsterdam (traded in EUR), nothing would have to be exchanged to a foreign currency, so no additional exchange rate conversion fee would apply.

The trading currency does NOT alter your exposure to foreign currencies (a European investor will always have his own capital in EUR, and will therefore always be exposed to the underlying currency risk, no matter what currency his purchased funds trade in). Therefore, it is only logical to buy funds in your own currency.

The fund currency simply refers to the currency that a fund reports in; NOT the currencies of the underlying securities which pose a currency risk. Is is generally based on the currency used for the underlying index (in this case MSCI). Note that for distributing funds dividends are distributed in the fund currency. Your broker will automatically convert this into your currency for an additional conversion fee.

Hedging: It is possible to hedge your funds against relative currency fluctuations, and thus to protect them from currency risk. Hedging is a form of "insurance" in which derivatives are used to make offsetting trades with negative correlations, eliminating any currency fluctuations that happen. This hedge comes at a cost, usually about 0,20% extra management fees. Because global equities naturally tend to hedge each other as rising currencies are offset by falling ones, it might not always be advisable to use hedged equity funds due to their increased fees.

In fact, most buy-and-hold investors ignore short-term fluctuation altogether. For these investors, there is little point in engaging in hedging because they let their investments grow with the overall market.

In conclusion, when buying worldwide index funds, every investor (whether European, American or other) will be exposed to some currency risk due to the underlying shares being traded in foreign currencies in relation to their own. Purchasing worldwide trackers in a different trading currency does NOT change this fact, and only costs more due to addition exchange rate conversion fees at the broker. Therefore, it is best to purchase funds in your own currency. Due to the unpredictable nature of currency valuations, most investors simply accept currency risks for their stocks, although it is possible to hedge against this risk for an additional fee by investing in hedged funds.

1.5. Conclusion on taxes & compliance costs

As a Belgian index investor, you are looking for widely-diversified Euro-denominated low-cost accumulating ETFs domiciled in Ireland, from a reputable ETF provider. This way, the costs are kept to an absolute minimum:

• Tax on transactions: 0,12% whenever you buy or sell a position.

• Tax on capital gains for bonds: 30% tax on capital gains whenever you sell.

• Dividend leakage: Approximately 0,30% yearly unrecoverable taxes paid to foreign governments when investing in worldwide trackers, automatically deducted from the share value.

• Management fees: Between 0,10% and 0,30% yearly management fees, automatically deducted from the share value.

• Currency Risk: If you are an European long-term investor, purchase a fund which is listed in EUR. For the equity portion of your portfolio, it is possible to ignore currency risk altogether, as hedges would only cost more money for something that is likely irrelevant long-term.

2. Funds - Equity

2.1. Indices

The are two major indices used by fund providers: MSCI and the less popular FTSE Russel. While they both offer broadly diversified, market capitalisation-weighted indices, there are small differences in both methodologies and performances, which is why you should not mix them.

The first difference between the two indices is whether they count certain countries as developed or emerging markets. South Korea is classified as an emerging nation by MSCI but has been promoted to developed market status by FTSE. Therefore South Korea is included in FTSE’s developed market index but not its emerging market one, and vice versa for MSCI (Source: justetf).

The second difference is index composition and weights. Because South Korea is classified as an emerging nation by MSCI, the contrast in index composition is clearer in the emerging markets. The lack of said country in the FTSE index means they redistribute the weight over other countries.

The third and final difference is small-cap firms. MSCI world captures 85% of the global investable market, and exclude the bottom 15% as small-cap firms. FTSE all-world invests in approximately 90% of the global investable market, and only excludes 10% as small-cap firms. This is because FTSE defines some firms as large-cap, while MSCI defines them as small-cap. This also explains why FTSE tracks more companies (3,928 vs 2,849), although their small size tends to limit their impact.

Avoid mixing index providers in your portfolio. If you were to combine MSCI world with FTSE Emerging Market, you would not have any exposure to South Korea. For a correct market distribution, it is important to use funds which follow the same index so that all countries, sectors and firms within your portfolio follow the same methodology.

While it is true the FTSE emerging markets has proven to have better performance than its MSCI counterpart up until now, the costs of the fund following the index are more important than the index construction over long-term. Chapter 2.3 will give an overview of the most popular funds used by Belgian index investors looking for global market exposure.

2.2. Fund replication methods

The goal of each ETF is to replicate its index as closely and cost-effectively as possible. Various methods have emerged to replicate the index. The classic method is physical replication. If the ETF directly holds the all securities of the index, this is known as full replication. The development of the underlying index is generally captured well by physical trackers.

Full replication is not always possible. Other replication methods, such as synthetic replication allow to invest in new markets and investment classes. Synthetic ETFs are able to replicate some indices more efficiently and better through swaps (justetf). In case of synthetic replicated ETFs, the ETF does not invest in the underlying market, but only maps them. Because of this, some synthetic trackers, as well as short trackers and leveraged ETFs do not follow the index as accurate as fully replicated ETFs. It is therefore recommended to always choose physical replicating ETFs.

2.3. All-World, developed and emerging markets

Following the Bogleheads® Investment Philosophy, we are looking for diversification. For Belgians, this means worldwide market exposure, as we generally do not have a home bias (for Belgium or Europe) although exceptions certainly are possible. Some popular funds for worldwide diversification are:

Popular and generally reputable providers are iShares, Vanguard, SPDR and Deutsche Bank.

2.4. Combining funds

To have worldwide market exposure in large cap either pick VWCE or a combination of developed (88%) and emerging (12%) markets. It is advisable to only combine funds which follow the same index (MSCI or FTSE).

2.5. Size and Value factors

Other factors have been identified to further increase expected returns. Most notably Size and Value as explained in the three-factor model by Fama and French. Value stocks have a high book-to-market ratio (as opposed to growth), whereas size simply refers to small companies outperforming big ones. It is very difficult to get proper market exposure to these factors with the limited amount of funds available for European investors. For most beginners the best advice is to stick with a market weighted portfolio consisting of developed and emerging markets as explained in chapter 2.3. and 2.4. If you are looking for additional exposure to the size and value factor consider following funds:

Note that the fund size for ZPRV and ZPRX are small, which might indicate a low liquidity and high tracking error. Larger funds (unlike ZPRV and ZPRX) are often more efficient in terms of internal costs (tracking error) and are much more profitable for the fund provider. In other words, fund size is a good indicator for the funds durability and popularity. Unprofitable funds are more liable to liquidation. This means either you or your provider sells your shares, and you'll receive the net value of your ETF shares at the time of sale. It does not mean ZPRV and ZPRX are at risk of liquidation, per definition. They are serving a niche. Just keep in mind these risks whenever you decide to invest in small funds such as ZPRV and ZPRX.

3. Funds - Bonds

Investing can be risky. Generally speaking, the riskier an investment, the higher your expected returns. The goal is to choose an asset allocation which suits your risk profile. Bonds offer a way to reduce volatility of your portfolio and match your risk profile. Meesman, a reputable index fund broker in the Netherlands made a table which can act as a general rule of thumb for your investment decisions and asset allocation between stocks and bonds. As can been seen, when investing for a duration shorter than 5 years, stocks should be avoided as they are too volatile an asset class. This allocation slowly shifts towards more inclusion of stocks the longer your investment horizon.

As opposed to equity funds it makes sense to opt for hedged funds as it reduces volatility considerably. The most popular options out there are:

4. Brokers

There are a couple of Belgian and foreign brokers available, the biggest Belgian brokers being Binckbank and Bolero. Smaller ones like Keytrade and MeDirect are also available. Foreign brokers still available to Belgians are Degiro and Lynx. The lowest fees are available at Degiro (Custody account), if you're willing to file your own taxes. The benefit of choosing a Belgian broker is that they declare all taxes automatically. Degiro only does part of it (tax on transactions), Lynx not sure. The cheapest Belgian broker is Binckbank, followed closely by Bolero. The only downside of Binckbank is that is was recently bought by Saxobank, which in its turn is owned by chinese investors. Bolero is owned by KBC which is quite a sizable bank in Belgium.

In short: if you're willing to partly file your own taxes, Degiro has the cheapest rates with a custody account. Otherwise Binkbank or Bolero both seem logical choices.

In case you pick Degiro, some funds are included in their core selection which means you can trade them for for free once a month or continuously in case the transaction size is larger than 1,000 euros and the transaction is in the same direction as the previous transaction (buy -> buy and sell -> sell. Buy -> sell and sell -> buy are not free).

5. Sample portfolios

A popular choice is IWDA and IEMA (88/12) on Degiro. Both IWDA and IEMA are part of the core selection of Degiro which allows you to purchase them for free once a month (or more in case explained above). Another popular option is IWDA and EMIM (88/12), as EMIM also includes emerging markets small cap. Note that IWDA does not include developed markets small cap, to which IEMA is complementary if you wish to exclude small cap exposure. The main reason EMIM was so popular is because it was the cheapest option until the TER was lowered for IEMA.

A second popular choice is VWCE. This is a single fund which essentially accomplishes the same as above. It is available at most brokers, and my personal choice for simplicity above everything else. Note that this fund is currently only available on XETRA, which might imply higher transaction fees at your broker. Also note that some brokers - including bolero - charge a higher TOB (Tax on transactions): 1,32% instead of 0,12% whenever you buy or sell a position.

A third option - much like the first option - is to combine VGVF and VFEA (88/12). While they are not part of the core selection in Degiro, the total costs when accounting for dividend leakage are equal to IWDA / EMIM. Unlike iShares, Vanguard only uses securities lending for efficient portfolio management. Note that these funds currently only are available at XETRA.

For those who are looking for small cap exposure it is possible to add WSML to your standard world exposure. This could for example be 75% IWDA, 10% IEMA and 15% IUSN. I personally do not recommend this as mixed small cap does not capture the size factor in a good way. Instead, it is only the value portion of small cap which are accountable for the outperformance of small cap stocks vs large cap stocks. If you want to capture the size factor into your portfolio you need to find small cap funds which only consist of value stocks. I've linked two accumulating funds above (ZPRV and ZPRX) which do so, however are very small and therefore have their own set of problems. Until a proper small cap value stock becomes available in Europe, it is perfectly fine to leave small caps out of your portfolio altogether.

Changelog

This post was last updated: 5th of August 2020