It is now possible for retail investors in India to directly buy US stocks. One question that is now becoming popular among the investor community is, “can I buy US stocks (in particular US tech stocks) directly instead of investing in a US index like Nasdaq 100 or S & P 500?” SEBI registered fee-only advisor Avinash Luthria explains what investors should do.
About the author: Avinash is Founder, Fee-Only Financial Planner & SEBI Registered Investment Adviser (RIA) at Fiduciaries. He was previously a Private Equity & Venture Capital investor for 12 years and has a flagship-course MBA in Finance from IIM Bangalore. His articles about Financial Planning & Investing have appeared at Business Standard, Mint and The Ken.
In an article in April 2020, I had answered ten FAQs about international investing – Finally, a way to invest abroad with the Motilal Oswal S&P 500 Index Fund. That article was an update to my 2018 Business Standard article – You can mitigate domestic risks by investing abroad, here’s how. Pattu asked me to respond to two additional FAQs. First, a simplified summary of the April 2020 article is:
Significant international diversification is very important. Unfortunately, there are very few attractive products, so it is difficult to achieve this. I subjectively prefer the Motilal Oswal S&P 500 Index Fund to all other Indian mutual funds which allow you to invest outside of India.
1 Does it make sense for me to buy specific US stocks, particularly US tech stocks, via an international stockbroker?
Some of us may treat say 5% of our net worth as an experimental portfolio. This experimental portfolio could be used to experiment and learn about investment products or asset classes that we are not familiar with or where we are taking a high risk. The thinking is that even if the value of this experimental portfolio went to zero, we would still be able to get through retirement with a 5% reduction in our lifestyle. So, the discussion below is not about this 5% experimental portfolio but about the remaining 95% of our net worth which we cannot afford for it to be wiped out.
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I have written 20+ articles, over the years, explaining that one should use index funds instead of active mutual funds and other complicated products. This article in Business Standard is a good starting point and it explains that the average mutual fund manager in India does not have the skill to beat the index, net of costs – The average Indian active mutual fund does not beat the index – Ignore false arguments against index funds. And an article that I wrote in FreeFinCal partially explains the intuition for why it is so difficult to beat the index – Avoid mistakes & minimize costs through index funds: Don’t waste energy fighting the law of no-free-lunch.
Further, the latest S&P Indices Versus Active Funds US report shows that only 13% of US Active Mutual Fund managers were able to beat the index over the last 15 years. Since luck plays a significant role in the outcome, it is difficult to deduce whether investment performance was due to good / bad skill or good/bad luck. For example, due to good luck, an active mutual fund run by the random number generating function in Microsoft Excel spreadsheet software may beat the index.
Similarly, due to bad luck, it is possible that the most skilled investor in the world (who would have to be a genius) does not beat the index. So, it is very difficult to measure skill. But since we cannot rely upon luck, we still have to focus on skill. And specifically, what we have to answer is whether you, the reader, are a massively more skilled investor than the best US Active mutual fund managers.
To cut a long story short, to the best of my knowledge, there is either zero or one investor in the US that has demonstrated, beyond a reasonable doubt, the skill to beat the index in a legal manner. This hedge fund’s returns are so good that it is highly unlikely to be due to luck. But there is insufficient publicly available information to know whether their approach is and was entirely legal. To clarify, I am definitely not claiming that their approach is not legal. I am just saying that based on publicly available information, no one knows. And there are currently no external investors in the flagship fund of this hedge fund i.e. the only investors in the flagship fund are founders and employees.
Hence having the skill to beat the US indices in a legal manner is massively more difficult than being a competent brain surgeon (Note: The skills are different, so the point is about which skill is rarer). To clarify, I am not claiming that mutual fund managers have this skill. None of us expects that we can do the job of a competent brain surgeon without dedicating our life to it. Similarly, it is extremely arrogant to assume that we have the skill to pick stocks and beat the index.
You might say that even if you do not have the skill to beat the index, you think you have the skill to match the performance of the index. The reality is, that one has to be a very good investor to have the skill to even match the index. A necessary but not sufficient condition to be a very good investor is that you should have put in at least 10,000 hours of effort into being a direct equity investor. If you later realize that you are not a very good investor, you might by then have underperformed the index by an average of say 2% p.a. If so, over a period of 30 years, you would have cumulatively underperformed the index by 45% and you would have jeopardized your retirement.
It is possible that you doubt that 10,000 hours of effort is a necessary (but not sufficient) requirement to be a very good investor. If so, you could try to answer one of the questions that I provided in an article in FreeFinCal and I am providing it here for convenience: “Two large listed companies in India, X & Z are identical in every way and also both have the same return on equity as the NSE NIFTY 50 index. X is expected to keep growing at 0% p.a. and Z is expected to keep growing at 4% p.a. Then, what should be the ratio of the Price-to-Book of Z to that of X and why?”. Being able to correctly answer this only moderately difficult question is a necessary but not sufficient condition to be a very good investor. So, if one cannot correctly answer this question, then one should not be doing direct equity investing. Please note that I am not making any statement here about the opposite scenario i.e. if one can correctly answer this question.
In summary, if you don’t have the skill to beat or match the index, then your direct equity investments could massively underperform the index and hence jeopardize your retirement. Hence, you are better off investing via an index fund. Currently, there are insufficient suitable index fund products that invest outside India, but a solution to that is complicated and is outside the scope of this simple article. Hopefully, over time, there will be more suitable index fund products that invest outside of India.
Is it really that complex to invest via an international stockbroking account compared to the Motilal Oswal S&P 500 Index Fund?
Yes. The April 2020 article mentioned that “This is a complex topic and hence it is outside the scope of this article” and the same is true for this article also. The April 2020 article lists several tax-related aspects that you have to evaluate along with a suitable CA. Very few CAs will not have much knowledge about this topic, so you will have to find a suitable CA. There are other complex aspects that are not covered in the April 2020 article. For example, a major aspect is Estate Tax in the US. And a minor aspect is, Indian Tax Collected at Source of 5% of the amount above Rs 7 lakhs p.a. which became effective from 1st October 2020.
Further, the April 2020 article mentioned that Interactive Brokers’ minimum guaranteed revenue for the broker of USD 10 per month (i.e. around Rs 9,000 p.a.) subjectively makes it ideal for someone who expects to have a cumulative investment of around Rs 50 lakh through this route, over the next five years.
Theoretically, the primary benefit of an international stockbroking account is to be able to invest in products such as the Vanguard US S&P 500 ETF and hence reduce the fees compared to say the Motilal Oswal S&P 500 Index Fund. But that is a complicated process. Hence practically, the primary use of an international stockbroking account is that there are very few suitable Indian mutual funds that invest outside India. Hence after you have run out of such suitable products to invest in, you may be forced to consider an international stockbroking account.
Hence, pick suitable Indian MFs that invest abroad before opening an international stockbroking account.
Articles that I have written about related topics:
- Bloomberg Quint video: Why I don’t recommend Smart Beta / Factor Investing / Quant Funds
- Emotional arguments against Index Funds – It is rational to use index funds and irrational not to
- Beware of claims that contradict finance theory – A lot of propaganda in personal finance contradicts the fundamental law that there are no free lunches
- PMS investment is too risky
- Why individual investors should avoid Alternative Investment Funds – You should invest in a PE / VC / Hedge Fund only if you can manage such a fund
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