Investing plans with the upcoming new NISA

16 Nov 2023 | #japan | #money

From 2024, Japan’s tax-free investment system, NISA, is getting a major overhaul. Investments made within the system are tax-free (no dividend and capital gain tax), with the only major limitation on yearly and lifetime contribution limits, and that a third of the limits can only be used for mutual funds. This is not a retirement scheme, and there is no penalty for selling early. In this post I will review how I plan to invest from 2024.

What to invest in

Going with the general advice and the “Diversification is the only free lunch” principle, I’ll continue to invest in low-cost diversified index funds or ETFs.

Which index?

Many people invest in S&P500 (the 500 largest companies of the US), which had exceptional returns in most of the last century as America became the leading economic power in the world. There are similar indexes in other countries (e.g. Nikkei 225 for Japan, or DAX for Germany), and some people prefer to invest in companies of their own country.

To me picking a country and hoping that it continues to do well seems like only doing half of the diversification. Will China overtake the US, or will China become the next Japan? Will India or Indonesia be the next China? Will the EU’s or Japan’s economy wake up? I don’t think anybody knows the answer to these questions, especially not at the timeframe I’m investing (majority of it is for retirement 30-40 years from now).

Thus I invest in index funds or ETFs that track the entire world economy. This way as long as the world economy continues to grow, I will make money.

Is it possible that this assumption is incorrect? Of course. Population is declining in most advanced economies, and population growth is slowing globally too. The UN expects population to peak around 2080 with most of the growth coming from the period until 2050. The world has never seen widespread population decline, so we don’t know how this will affect the economy. However with declining population other investments are also risky: the price of real estate, and precious metals are both driven ultimately by demand, which might decline with less people, and with the ever increasing amounts of government debt, money printing leading to inflation seems also a likely possible future for many countries. So I think that overall investing in the entire global economy is still the best course of action.

Which fund/ETF?

I already looked at the existing all-world ETFs in my earlier post. A few learnings I took since then:

1. Always invest in yen denominated securities. This is mostly due to how Japanese taxes work: capital gains are taxed at a fix 20%, but forex gains are considered miscellaneous income and taxed at the marginal tax rate (30-40%). Moreover these two being a different tax category, I believe they can’t be used to offset each other. Moreover forex gains are not tax-free in NISA.
2. If possible, find a fund that reinvests dividends. The new NISA has contributions limits only, but the amount in it can grow indefinitely. Automatically reinvesting dividends thus increases the tax-free investment amount.
3. Stay away from currency-hedged investments. Recently the yen dropped to historical lows against the dollar, so some people are looking at funds that provide currency hedge (e.g. if the S&P500 goes from $4500 to $4950, then the fund’s value in yen will also increase 10%, regardless of the exchange rate change). This sounds good, however it comes at a huge cost that’s often hidden in the fund descriptions. This cost eats into the profit on long time horizons, while currency fluctuation tends to even out in decades.
4. Avoid funds that wrap other funds to limit double/triple taxation

I found that eMaxis Slim All Country (ｅＭＡＸＩＳ Ｓｌｉｍ 全世界株式（オール・カントリー）) fits all of these with a low, 0.1144％ yearly fee (this is not too bad even compared to Vanguard’s VT’s 0.07% fee). If you are looking for an alternative, I recommend checking out the other eMaxis Slim funds as they are all pretty low-fee, yen denominated, and they all reinvest the dividends.

When to invest?

The new NISA has a yearly limit of 3.6 million yen. Assuming the entire amount is available in January, is it better to invest it immediately or to split it into 12 parts and invest each month?

These two strategies are commonly referred to as lump-sum investing and (dollar) cost averaging. Research finds that lump-sum investing is a better strategy:

Using MSCI World Index returns for 1976–2022, Finlay and Zorn calculated that LS [lump-sum] outperformed CA [cost averaging] 68% of the time across global markets measured after one year.

This makes sense: if we expect markets to go up on the long term (which has been true historically for most markets and timeframes), then investing everything early ensures we get all the returns. In other words, while prices fluctuate, in average it is more likely that prices later will be higher than earlier.

On the other hand this also means that 32% of the times cost averaging was more beneficial and the research also notes:

But for some risk-averse investors, a CA approach may be more suitable, because it reduces the risk of drawdown or even abandoning their investment plan altogether because they fear large losses.

I understand this as: investing all the money at once, then market drops, feeling bad about it and potentially selling at a loss. While with cost averaging if the market drops after the first investment, one can more easily look at the bright side that next month they will invest at a lower price.

One other thing to note: some brokerages have campaigns that gives you points for investing using a credit card up to a certain amount (SBI has one for investing 50,000 yen/month from an SMBC card). Investing using a credit card sounds like a pretty bad financial decision, but if you can pay it off next month, then it is just free points (which are essentially money).

So my plan: every month invest only the amount that maxes out any campaign, and invest everything else in January as lump-sum.