American Expatriates—What Your Financial Advisor Probably Doesn’t Know

If you’re an American expatriate, and you’ve been living overseas for some time, it’s likely that the vast majority of your investments will be in taxable accounts. 

As a non resident, your ability to invest in a IRA (tax deferred account) is limited to just $5000 a year if you’re under age 50, and $6000 a year, if you’re over age 50.  …more info 

Financial advisors dealing with expatriate Americans will understand these limits.  But there’s something that many advisors don’t know—and their lack of knowledge here could cost you tens of thousands or hundreds of thousands of dollars.

The Paradox Your Advisor Doesn’t Know

Let’s assume that you invested $10,000 in five stocks, and you owned those stocks for ten years, generating an average return of 8 percent per year in a taxable account.

Now assume that—in a taxable account– you’ve invested another $10,000 in an actively managed mutual fund that averages 9 percent a year over the same time period.  Which scenario would give you the highest return?

The answer seems painfully obvious, doesn’t it?

But it isn’t.

You would make more money investing in five stocks, generating 8 percent per year than you would in an actively managed mutual fund generating 9 percent a year.

How Can An Eight Percent Return Beat A Nine Percent Return?

When money is invested in a taxable account, it can compound (free of capital gains taxes) until the asset is sold.  So if you owned 5 stocks, averaging 8 percent a year, you wouldn’t pay a penny in capital gains taxes until you sold those stocks.

But actively managed mutual fund investors don’t benefit from the same perk.  For example, actively managed funds hold stocks that are traded by fund managers.  If a fund manager sells a stock at a profit, the fund’s investors get handed the tax bill.  Rather than the mutual fund compounding capital gains free, it creates a tax bill for its investors as it appreciates.  If the fund appreciated every year, the investors that own that fund would pay capital gains taxes every year. 

How Do You Get Around This?

I’m not going to suggest that American expatriates fill their taxable investment portfolios with individual stocks.  However, if their investment portfolios are comprised of index funds, the money can compound, virtually capital gains free—even in a taxable account.

Let’s use Vanguard’s total stock market index as an example.  It had an annual holdings turnover of just 5 percent last year.  … more info

This means that the fund sold only 5 percent of its stocks last year, and it held on to 95 percent of them, year over year, ensuring extraordinary tax efficiency.

The average actively managed stock fund in the U.S. has a turnover that’s fifteen times higher than that, creating a significant (after tax) drag on returns as the mutual fund managers bought and sold stocks within their funds.

The Tale of Two Funds

If you had invested in The American Funds Investment Company of America mutual fund, your pre-tax returns from 1979 to 2003 would have been an impressive 13.7 percent per year.

If you had invested in Vanguard’s S&P 500 index fund, from 1979 to 2003, your pre-tax return would have been 13.8 percent per year.

There’s little difference between the two performances, right?


In John Bogle’s excellent book, Don’t Count On It!  Bogle lays a comparison between the two funds, assuming that they were each invested in a taxable account.


Amount invested in 1979

Amount invested after sales fees

Average percentage gain

Pre-Tax Value, 2003

Estimated annual taxable liability

Est. Post tax annual return

Est. Investor’s value in 2003

Vanguard S&P 500 Index (VFINX)



(no sales fees for Vanguard)






American Funds (ICA)


$9,425 (after 5.75% sales fee)






Source: John Bogle, Don’t Count On It! Pg. 384

Before taxes, from 1979 to 2003, the Vanguard S&P 500 index and the American Funds Investment Company of America earned virtually identical returns: 13.8 percent and 13.7 percent respectively.

But after tax, there was a huge difference in performance.

Actively managed mutual funds don’t make much sense in taxable accounts.

Jason Zweig, when writing for Money, interviewed investment manager, Ted Aronson, who suggested that, after taxes, active management can’t win. Aronson manages more than $2 billion, and despite being an active money manager himself, all of his family’s taxable money is in index funds. 

Expatriate Americans, when investing money, will direct the bulk of their savings to taxable accounts.  And sadly, because of their advisors’ cravings for commissions, that money will likely find its way into actively managed funds.

Before taxes, roughly 85 percent of actively managed mutual funds will lose to stock market indexes.  And we’ll never know which 15 percent of actively managed funds will beat the total market index, over the next five years, ten years or twenty years.  Gambling your retirement money on such low odds is foolish.

But even if you get lucky, and find a fund that ends up beating the index, will you really be coming out ahead, in a taxable account?

It’s highly unlikely.

Your investment advisor probably doesn’t know this.

And his or her ignorance–or conflict of interest–could cost you tens of thousands (or hundreds of thousands) of dollars over a working career overseas.

In my next post, I’ll show you the pride and joy of the expatriate American Funds salespeople.  It’s a fund that has a long-standing historical record of thrashing the indexes.  A fund’s historical performance is a poor gauge  of how it will do in the future, but that’s not the point I’m going to make. …more info

I’m going to prove that it hasn’t had such a stellar after-tax historical performance after all.  Stay tuned. 



Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School and Millionaire Expat: How To Build Wealth Living Overseas. My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I'm happy to comment on your questions.

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21 Responses

  1. Chris says:

    Howdy there Mr Andrew, Well as you know I'm not an ex-patriot yet! Still living here in Sacramento investing 5000 a year in a Roth IRA. OK I understand how this works! I can not deduct these contributions every year as I inject them into my Roth index fund VTTHX ,thus allowing me to withdraw the funds at retirement tax free. Now If I start a Traditional IRA as well and max that every year I will Pay a federal long term tax of 15% OK I don't really care for that but on top of that Andrew I also have to pay the State of California 9.3%……..What the.. *%@x#@… tell me it's not soooooooo! OK now I'm discouraged…..Really 9.3% to the State of California? Any other wise advice to your fans here state side? Maby there's a legal way around this State tax gains like starting my second IRA in say Alaska…..which I must say has the biggest and tastiest Halibut you ever tasted in your life! Sincerely Chris the Truck Driver

    • Hey Chris,

      That sounds hilarious–starting a IRA in Alaska!

      You might want to sit down with an accountant to get all the goods on taxes. Just make sure the accountant doesn't sell financial products on the side!

      Then let me know what you've learned.

  2. DIY Investor says:

    Excellent post! It takes a little digging to understand exactly what you are looking at when you look at returns but the effort is well worth it! I liked the mention of Aronson. What the big boys do is very telling.

    • Hey Robert,

      Thanks for the compliment on the post.

      Yeah, Aronson is definitely a rare breed: totally honest and transparent. I love the fact that he tracks his family's money for everyone to see. And based on his very objective, mechanical rebalancing, his collection of indexes has done really well.

      Keep up the great work yourself Robert!


  3. 101 Centavos says:

    Nice post, Andrew. Your run-of-the-mill vanilla investment advisor won't even broach this subject of total *net* returns in after-tax accounts, merely mouthing the standard playbook about risk tolerances vs. age vs. income brackets = stock/bonds/cash allocation.

  4. Hey Centavos,

    What percentage of American advisors do you think even know this?

    I often wonder about that.

    • 101 Centavos says:

      I wouldn't hazard a guess, but probably not many.

      Perhaps I'm biased, but the couple that I've spoken left me profoundly unimpressed. They were just trying to sell a product.

      • Hey Centavos,

        I think you're right. It's mostly a sales gig.

        But when advisors convince investors to buy actively managed funds for taxable accounts there's an element of immorality associated with that. Ignorance, on the part of the advisor, isn't an excuse.

  5. woodes34 says:

    Fantastic work as always Andrew!

    Please present at EARCOS again next year. More people need to hear what you have to say. Will you do a post at some point in the future about the costs of leaving a portfolio with active managent and/or transferring it to a passive model. How does one go about this?

    Thanks again!

    • Hey Woodes 34:

      Thanks for the kind words. I would love to present at EARCOS again next year.

      Sometimes, switching over to a passive model doesn't cost a penny. It can be as simple as just selling and having the money transferred to another account. I have seen a number of friends transfer to Vanguard. Are you thinking of making a switch? And from where? What financial service company are you using? What are the names of the funds you own? If they don't have "back end loads" associated with them, then it won't cost you a penny.

  6. Great post Andrew.

    Even as a Canadian there are a lot of gems to be found here.

    One striking point from the chart that you don't touch on (in this particular article) is that it isn't only taxes, but also fees.

    The person who pays "5.75%" just for the privilege of owning one of these funds has to gain over 6% just to break even. That "5.75%" will leave an enduring scar on the portfolio.

    As an aside, I am a little lost (re: the chart) of why you have 2011 pre-tax value, and 2003 value. Or is it supposed to be pre-tax and post-tax for the same year?

  7. Merely to play Devil's advocate, I wonder what argument could be made for the assumption that people tend to move up in income and tax brackets over their lifetime.

    If a 25 year old invests $10,000, could it be possibly be advantageous to be paying capital gains tax while they are in a lower bracket, than to compound those gains over 30 years and then pay the taxes in a higher bracket?

    (Personally, I would say it is better to compound it and then remove it wisely over a number of years, but for the sake of argument…)

  8. Hey Myke,

    Thanks for pointing out the error in my date. It should read 2003, not 2011, so I'm going to change it. Thanks for that!!!

    As far as the load fee goes, you're right, but I did include that in the calculation. You can see that the American fund (unlike the Vanguard fund) doesn't get to start off with $10,000. It starts off with $9.425 after the 5.75% sales load.

    Your argument about the taxes can be answered pretty easily.

    When taxes are paid annually, that money can't compound. And that tax is paid at high rates of tax (the investor is earning a salary during the time that they're investing so their tax bracket is higher)

    When they are no longer earning a salary, they are taking money out at the lower tax rate. So it's better to let the money compound, and then pay taxes at the end, rather than pay taxes along the way at a higher rate. It's a bit like a RRSP.

  9. Thanks for the reply Andrew,

    Haha. Well, I didn't exactly mean to point out the error as much as I wanted clarification. But I guess since we are both teachers, we can appreciate that sort of thing. I give my students bonus points if they catch a mistake that I make on the board.

    Yes, I see the fee in the calculation, and of course know that you understand it fully. I should have clarified, as what I meant by that is that it is unfortunate how some people are enticed by a pamphlet that says 13.7% per year, when they end up starting with a lower base amount on which to add that 13.7%.

    (That's also why I put the 5.75% in quotations, as the salesfolk love to make it seem less than it is… )

    I understand your point about the loss of compounding, but I still wonder about it. A 25 year old may be making 25 grand and paying little in taxes… maybe he or she then gets married and has children which lowers his/her taxable income, even with raises…when he/she retires and wants to draw 40 grand from the portfolio with no dependants, well the bracket may make the compounding a lost cause, no?

    Again, simply as an argument for the sake of light.

    To be perfectly honest, I think the calculation has too many variables. On one side, we would have to figure out what the average salary and taxes were for a person back in 1979. We'd also have to add inflation into the mix. On the flip side, and to use today as a start date, we have no idea what tax rates or inflation will be in the future.

    As a proponent of indexing and individual holdings, I may be copping out on the too many variables. I'm sure someone could do it. Maybe I'm not such a good advocate of the Devil 😉

  10. True, we'll never know exactly what the tax hits will be because every individual is different, but the spread between "buy and hold" and "trading" will be somewhat consistent, regardless. Academic study after study supports the same premise that actively managed funds are less efficient in taxable accounts. There's no study that refutes that.

    That's why fund managers like Aronson won't even put his own taxable money in his own fund. His non taxable money, yes. His taxable money, no.

    To read, in detail, how taxable investors fare, when comparing indexes to actively managed funds, you can check out the very respected academic paper written by Robert D. Arnott, Andrew L. Berkin and Jia Ye, titled, "How well have taxable investors been served in the 1980s and 1990s". It was published in the Journal for Portfolio Management 26, No. 4 (Summer 2000)

  11. Thanks Andrew,

    I'll give that paper a read. I suspect I'll enjoy it, and fully believe that active management has serious tax drawbacks.

    As you know, Canadians and American ex-pats have very different situations when it comes to taxes in our home countries. Since I don't have a portfolio large enough to generate tax implications on fund distributions, it hasn't directly affected me.

    The MERs alone keep me well away from active management.

    Come to think of it, perhaps my question was only applicable to Canadians? I think Americans pay a flat tax on capital gains, which would make annual income irrelevant.

    As an interesting side note, I just did that personality test linked from Kevin's site. I came out as ENTP. The description said ENTPs enjoy being Devil's advocate, and argue to find an answer.

    An interesting bit of synchronicity, if nothing more 😉

  12. Matt says:

    I am an America Expat currently teaching in Tanzania. I need to set up a retirement account, but I know that many options are closed to me as a result of the Foreign-earned Income Exclusion. It is difficult to find advice on how and where to invest my foreign-earned income so that I can save for retirement and not run into some serious issued when I decided to return to the states.

    Numerous peers have Vanguard accounts set up with US-based addresses that they maintain but do not reside at. Vanguard does not seem to want to deal with expat US citizens directly.

    Do you have any advice for a fellow teacher that is looking for a safe place to invest their foreign-earned income that will not run afoul of the IRS at a later date?

    Thanks in advance.


  13. Hi Matt,

    If you want to open a Vanguard account and you have a U.S. address you could use, officially, as well as a U.S. bank account, you will have plenty of luck opening the account online and not speaking to a rep. The account will open, as long as you type in a U.S. address and not a foreign on.

    You could also speak to someone at You could open an indexed account through them, knowing that they welcome expatriates. The costs are very slightly higher than Vanguard's but the performances from their rebalancing (they do it for you) have more than made up for the fees. You can reach them at the following site: http://www.assetbuilder. Tell them I sent you and you might get better (or worse!) service. I'm kidding, they're great with everyone!

    Third option: Raymond James Financial have reps creeping all over the place, internationally. Most of them like to get their clients in expensive products. But if you can talk them into this, then do it!

    45% in the Fidelity Intermediate Bond Index

    30% in the Fidelity U.S. (S&P 500) Stock Index

    25% in the Fidelity International Stock Index

    These are REALLY cheap indexes available through Fidelity, and a Raymond James rep could buy them for your account. If they do this, they may try to charge you an extra wrap fee or account fee, which is often an annual percentage charge. DO NOT let them do this. There's an international rep with the initials JB (who works for Raymond James) who is notorious for charging wrap fees on top of mutual fund accounts. Be wary of this. If you do choose a Raymond James rep and request this option, hold your ground.

  14. Matt says:

    Thanks for the response. That is the most concrete advice I've received to date.

    With regards to opening a Vanguard account with a US address, I am just wary of that because it seems it would be easy for the IRS to see that I would be filing the Foreign-earned Income Exclusion form for the same years that I would be contributing to the Vanguard account, or wouldn't that matter? Is the only issue with the Vanguard account and foreign-earned income the fact that Vanguard just doesn't want to deal with me because of things like the HIRE act?

    Thanks again, Andrew.

    • Hi Matt,

      The IRS won't care. Not allowing expatriates to open Vanguard accounts is a very new roadblock that Vanguard put in place. It has nothing to do with the IRS, so you can rest easy there. We have dozens of U.S. expats who opened Vanguard accounts (where I work) and they file their taxes just like everyone else. It's not a problem with the IRS, trust me on that one.

      Another option could be seeing a Raymond James rep and following my latest post on that one.

  15. Erin says:

    I am reading your book now, it is great!

    I agree that if you take the FEIE, you may not have enough US taxable income left to be eligible for Roth contributions.

    However, there is no rule saying an expat has to take the FEIE. You can choose to report all the income and instead take foreign tax credits on it all. I haven’t used the FEIE in years. The tax owed is wiped out through foreign tax credits. We intend to invest in Roths once we move to the UK this summer. We have been in Canada where the CRA allows Americans to have Roths, but considers them taxable if you make a contribution from Canada.

    Of course, our tax strategy works because we are expats in higher tax countries, might not work in a lower tax country as foreign tax credits may not cover all US tax due.

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