Passive investment can seem like an ideal opportunity for expats to generate a reliable income stream over time without any continual portfolio analysis or monitoring.
Also known as buy-and-hold, passive investments are designed to provide long-term returns, subject to low risk, and without exposure to market fluctuations that can dramatically impact shorter-term investments.
However, it is important to understand the tax implications, anticipated time frame for returns, and the trade-off where lower risk could also equal lower profitability.
Passive Income Investment Explained
One of the drawbacks of building a passive income portfolio is that the initial investment threshold may be higher than for an actively managed fund or product depending on the investment you select.
The positive is that a stable investment can act as a hedge against volatility in other assets and provide assurances of a reasonably certain income, often accessed on retirement.
- Property investment: while not fully passive, property investment can be a diversification exercise and is common where expatriates retain a property at home, often outsourcing management to a local agent with property value appreciation increasing the asset value gradually, with rental income to cover mortgage costs.
- Index fund investment: stock market investment is rarely advisable without professional support, but an index fund can be an opportunity to invest in the market without rebalancing specific portfolio products or selecting particular investments.
The returns on investments of this nature could be favourable over the course of several years, with index funds often maintained for at least five years, and sometimes as long as 20 or more. Still, the premise is that the investor can effectively leave their investment to run its course without a huge amount of hands-on supervision.
Pros and Cons of Passive Investment for Expats
As always, the right investment products, portfolio and approach will differ for every individual, not least because your tax position, residency or citizenship status and financial goals will dictate the correct investment strategy.
Both passive and active income streams pose pros and cons.
Active Income Streams
Active investments can comprise multiple products or funds monitored and managed by your financial adviser or wealth manager. Usually, the fund manager makes decisions based on your instructions and priorities to adapt to market conditions.
Positive aspects of active investment include the following:
- The potential to outperform market averages when a skilled manager or adviser manages a fund.
- Access to niche markets, complex sectors or specific funds and products that align with your requirements.
- Data availability to allow your fund manager to research holdings, monitor investments and make quick changes where necessary to safeguard your wealth.
The pitfalls are that there is no guarantee that an actively managed portfolio will produce returns over and above a passive fund, and the possibility of losses can be greater. Fund management fees are often higher, depending on the level of involvement and work required.
Passive Income Streams
Passive investments typically include Exchange Traded Funds (ETFs) or other index trackers which follow an index or benchmark and attempt to replicate the market performance.
The advantages include lower fund management costs and proportionate returns equivalent to overall index performance. Passive investments can be an opportunity to diversify by investing in a pool of companies or markets rather than selecting a specific equity fund.
It is important to note that index funds may not always be equally diversified because a small group of companies that dominate an index can have a heavily weighted impact on overall returns. The returns available cannot exceed the market or index, and there is little ability to respond to changes in the market – a passive fund simply holds the index. This factor changes somewhat when referring to property or other physical assets, since they produce returns in a different way.
Passive investment tends to be more suitable to longer-term financial planning, since a property investment or index fund is typically retained for several years, rather than held as a short-term asset.
Taxation for Expat Passive Income Portfolios
Alongside the investment product, risks and returns, expats should also consider their tax obligations because a passive income stream or capital gain on a long-term investment asset will be subject to taxation.
This topic may be complex, as expats might have physical investments as well as financial products within their portfolio, based in different jurisdictions and with varying timescales linked to returns. For example, many British expats remain liable for HMRC taxes if they own a property in the UK and earn a regular income, even if they live overseas for all or most of the year, normally collected through the Non-Resident Landlord Scheme.
The tax treatment of other investments depends on your residency status, the amount of time you spend in each respective country, and where the income originates.
Income, interest earnings or returns could be taxable at local rates if you are a permanent resident or citizen of another country and normally pay your taxes there. Potential tax liabilities could comprise:
- Capital gains tax
- Dividend tax
- Income tax on interest earnings
- Taxable royalty income
Passive funds such as ETFs can be domiciled in a different country, so although all income from any source is usually declarable, your tax exposure will depend on the frequency, value, and nature of the income.
Likewise, a crystallisation event on a long-term investment asset or fund will give rise to an income declaration and applicable tax charge, which could affect the types of products you choose to invest in.
Blending Active and Passive Investments
Most expat investment portfolios contain a mixture of asset classes, passive and active funds, and products as a key way to diversify against risk and protect your wealth from significant losses.
We advise clients to select a specialist expat financial adviser or wealth management team because some funds are unsuitable or unfavourable for foreign investors.
Global diversity can also be advantageous, balancing currency exchange risks that could impact your real terms returns if your investment product is based in an alternative currency to your principal place of residence.
Overseas investment carries multiple considerations, and although passive income is often seen as a ‘safe bet’, it remains important to create a stable portfolio that reflects your position in terms of tax, residency, and income requirements. For further advice about building a passive income portfolio, the pros and cons, and how this would impact your long-term wealth, please contact your nearest Chase Buchanan Wealth Management office to arrange a convenient time to talk.