How to Invest in the USA
Admission time: One of my failing is assuming most people know what I know and that much of what I know is easy to learn. That failing comes from a lifetime of wanting to be the stupidest in the room or maybe that was just being the stupidest person in the room. I’ve never seen the point of having others think I’m the smartest person in the room. As then I wouldn’t be learning as much and I absolutely love to always be learning and extending myself. Oops, did I just flip from failing to self promotion? Let me be clear, I’m never the smartest and I make too many assumptions.
Assumptions of any kind are generally bad, as the old chestnut goes they make an ass of you and me (u and me). Once I know something it seems easy, I’m sure the same is true for you. It seems so easy that it seems hardly worth sharing. Today I want to share something that is so easy, I only have to how easy it is and encourage you to do it.
Investing in the USA
On the flip side, any North Americans wanting to invest in Australia should simply open an account with Interactive Brokers (IB), they make trading in Australia easy and the commissions are lower than the lowest discount brokers in Australia offer. I use my IB account to buy share here in Australia. Here’s some more information on investing in Australia.
Firstly, why should Australian’s bother investing in the USA.
- Diversity of companies. If you want to invest in tech, biotech, alternative energy or international companies then the US is the place to do so. If you want to invest in Chinese companies, then you’ll find their ADRs listed in America.
- Size. The Australian market is 2%, IIRC, of global markets. Size matters if you want exposure to the global economy.
- Because right now the Australian dollar is near to it’s all time highs and investing in the US actually decreases currency exposure rather than increases it as many people assume. Global trade is priced in US dollars. While most Australians think they pay for everything in Australian dollars, the reality is they are priced in USD. Most imports are priced in USD, that price is passed on to consumers, albeit converted to AUD. Holding USD decreases your currency risk.
- Options. There is little point in speculating in options in Australia. The spreads and fees are too high, the liquidity to low and one contract is a thousand shares. With all that working against you there is on way a small investor can succeed. In the US spreads and fees are low, liquidity on most issues are high and a contract is for one hundred shares.
For balance here are a few downsides.
- The US has had it’s brief day in the sun and is a civilisation in decline, or so some people say. The risk here is that the US economy has peaked and growth going forward will be inferior to other parts of the world.
- US dividends are taxed at 15% and are pretty miserly to start with. However, you can offset the tax back here in Australia, but that leads to point three.
- International investing complicates your tax.
- The US markets is currently slightly overvalued, even a little bit more than the Australian market.
- Since SOX more companies are choosing to list outside of the US.
Back in November 2008 I was encouraging my friends to start investing as it was the best time to get started. I wrote this article for them, Ready Set Invest, which lays out how to get started with investing. If you’re new to investing read that first, otherwise read on.
There is nothing difficult about opening an account with a US broker. Simplistically you fill in some forms and deposit some money, just like opening an account with an Australian broker.
American’s are spoilt for choice in low cost online brokers. Think or Swim, optionsXpress or my favourite Interactive Brokers, are all worth considering. Australian’s can open an account with any of them. From my IB account I can also buy Australian shares as well as shares in companies listed on most exchanges around the world, plus currency, options, funds, ETFs and on and on.
To help you choose here is my view on the brokers. If you want nice nice online tools for option trading and inexpensive execution then Think or Swim (ToS) is the broker for you. If you want ease of use and good free reports and data then optionsXpress (oX) is the one for you. If you trade slightly more frequently, at least twice per month, or want access to a wider range of products and countries then Interactive Brokers is for you. The other benefit of IB is incredibly low commission rates and the smallest slippage, though don’t expect much in the way of hand holding or ease of use. IB is really designed for professional investors rather than your occasional investor and you’ll pay a minimum of $20 per month in fees and commissions; $10 for market data access to US exchanges and $10 minimum in commission (your first $10 of commission per month are free, they say offset or something like that). As IB’s commission rates are so low two trades per month with IB will cost you the minimum $20, while at ToS or oX the cost will be around that or a little higher. Hence if you trade less than twice a month you’ll pay less with either of those, but with more than two trade IB becomes considerably cheaper.
I could hold you hand through the process, but all that is required is the will. Once you have the will go to the brokers website, fill in the application form, send them the stuff they need (normally witnessed passport and the like) and then transfer money to your new account. Transferring the money is easy and IB even lets you choose which currency you want to hold your money in, i.e. you can hold you money in AUD if you want, though of course if you’re buying US shares then they’ll convert the cost and you’ll then be short the USD. Speaking of which, the interest rates at IB are so low they are even cheaper than my mortgage.
Fell free to ask any questions if you get stuck. In summary; fill in the application form which is mostly on-line, send them some details/identity proof and then deposit some funds following their simple instructions.
[Update: There are some worthwhile comments to read. In particular Mark pointed out that IB do withhold 15% on Australian dividends which aren't 100% franked.]
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Hi Dean
As a client of Etrade, who look like they are about to offer foreign transactions, I am considering some US trading.
I note your comment on 15% tax on dividends. What is the situation with capital gains from share trading? Do you have to file a US tax return? Does US recognise SMSFs or something similar and is the tax treatment for them different?
Regards West Wind
Hi West Wind, nice to hear from you.
My issue with Australian brokers, or in the case of E-trade Australian arms of US brokers, is they charge high commissions on international trades. If it’s a one off trade that is acceptable, but for anything more I think a US based account is the way to go.
Capital gains. No money is withheld from any gains other than dividends. The 15% on dividends is also only for US dividends. So if you hold shares of Telstra in a US account they don’t withhold 15% from that, or if you hold a Bermuda based company like a reinsurance company that is traded in the US, but domiciled outside the US then no withholding on dividends applies.
SMSF Is simply a trust and is recognised, as is a family trust and other arrangements. You may need to send them a copy of your Trust document to among other reasons show that trading US stocks and/or options is permissible. They are treated exactly the same for dividend withholding.
Tax return No US tax return required. However, you need to keep a track of your trades and applicable currency. I used to track Fx rate on day of trades, but gave up as the ATO provides a monthly figure and through testing I found it all worked out by swings and roundabouts. If you’re doing occasional large trades then you might want to look at keeping track of Fx rate for the day of the trade and comparing it to the month and seeing what works out best. Though you can’t chop and change throughout the year, one method is required.
Hope you’re well and enjoying life.
Dean
I have an IB account for my SMSF with USD as the base currency, for investment in US stocks, ETFs and ADRs. I am very happy with it. The commissions are so low it makes me angry that Australian brokers can get away with charging so much. For example, through IB, you can buy 200 shares in a broad-market ETF, eg. SPY and only pay $1 commission. That’s a ~$20K transaction with 0.004% commission! It was a little bit of hassle at tax return / audit time, as its not like CHESS, so the auditor was a bit fussy about things, but in the end IB provided a document to the auditor that was satisfactory.
I also have an individual account with IB with AUD as base currency which I use to invest in ASX and US listed securities. This has been a bit more hassle, as IB don’t sponsor you into CHESS for the ASX listed stocks. This makes paperwork for dividends, etc, a lot more of a pain. US witholding tax has also been deducted from the Aus dividends, which doesn’t seem right to me.
Mark
Thanks for the feedback Mark. I’m also very happy with my IB account. I think it is worth mentioning that they pass through charges for market data subscriptions you subscribe to. ASX market data is ludicrously expensive at around $47 a month, so I don’t subscribe to that and rely on my Aus broker for market data. IB also provide a security logon token for accounts over some limit, $100,000 IIRC, and also allow portfolio margin which provides greater flexibility and less danger of margin calls.
Dividends I definitely never have withholding tax taken out of my Telstra or any other Australian shares. I just double checked this. So if you are then you should talk to IB about why they are doing that. I agree that not being sponsored into Chess has some downsides, proof for tax being one, no shareholder communication, attendance and voting at AGMs off the top of my head.
Great article Dean, it will motivate me to look into an IB account. My brokerage fees for the last 6 months were about $3000 so there’s a bit of saving there for me to look at.
With the international exposure, although it provides diversification, for most people, all their expenses are in AUD. At the end of the day, when we retire or spend it, we will need to convert it to AUD.
Although the AUD is at highs since floating, if you go back to the 70′s-early 80′s it was over 1. From the limited research I have done the high may have been ?1.5 in the early 70′s. I don’t have data for it in the 60′s or earlier.
http://commons.wikimedia.org/wiki/File:Aussie_exchange_rates.png
http://research.stlouisfed.org/fred2/categories/287
Hi Sean
I discount the pre-float figures. I was speaking to an ex currency trader the other day and he said in passing that the AUD:USD is bounded 0.55 to 0.95. His belief was that would hold with only very temporary possible exceptions due to GDP and growth rates, i.e. very long term constraints. You could open an IB account keep your base currency in AUD, keep your current account to get real time data if that is important to you, then do you Aus trades using IB and you’d at least halve your fees. The downside is your not in Chess and therefore tax is a little more hassle. Check the other comments for other issues. The Australian commissions are 0.08% of trade value with a minimum of AUD 6.
To your other comment. I didn’t mean to imply my style is better than yours, that is the exact opposite of my belief. It sounds like you’ve found a style that is right for you while still remaining open minded. I think that is the best path for success anyone can take.
All the best – Dean
Dean, your response to my comment regarding withholding tax on Aus share dividends through IB prompted me to chase it up with them again, since last time I got a pretty short answer. This time is more informative but no more satisfying:
“Please note customer’s holdings are registered under IB’s name(street name) as an US entity. Therefore, withholding tax are charged unless the dividend is 100% franked. For information on franking amount for individual securities, you may refer to the ASX web site. Please let us know if you have any further questions.
Thank you.”
Still seems a bit wrong to get slugged withholding tax as an Aus citizen on partly franked Aus dividends.
Mark
Hi Dean, you may be right but I wouldn’t discount the prefloat figures completely. As I understand it the AUD was pegged to TWI or basically the terms of trade in the 70′s. It’s still the case that the terms of trade, or export prices have a large effect in a floated environment. The last time we had a resources boom was the 70′s so it’s not unimaginable to me that the AUD could get back to 1.5 where it was in the 70′s.
Usually I’m a big fan of mean reversion trades but in this case the true range is not clear to me and I will step aside for what maybe a commodity boom. If the range is 0.5-1.0 then buying USD now is a good trade. However, if the range in the next decade is 0.75-1.5 then it is not such a good mean reverting trade because the mean will be above 1 or the current entry.
Hi Sean, I find it very improbable that this cycles commodity boom could continue without good economic growth resuming in the US. So I see the probable outcomes as economic growth resumes in the US and therefore USD strengthens or economic growth does not resume and commodities drop therefore AUD weakens. Perhaps during the next commodity boom when I approaching retirement US growth won’t matter, but for now their consumption still is the driving force.
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