The edge of the Swiss retail investor

Everyone is looking for an edge in the investment world. If you’re a Swiss investor, here could be yours…

Have you ever heard that Switzerland is a tax haven? Well, it seems like foreign wealthy individuals are able to pay very little tax using the lump-sum taxation regime.
But I bet that the residents of canton Neuchâtel will laugh at your face if you call them tax privileged.

Compared to the amount of « free service » that one gets, taxes in Switzerland are not that low. What I mean by that is: other countries might have high tax rates but day care will be essentially free. Or the state might support students financially. Or citizens may not have to pay 18 francs for a photocopy.

Switzerland is like flying with EasyJet: the ticket is cheap but everything else comes on top. Now if you’re someone who bring his own water on the plane and has no carry-on, EasyJet is a good deal. But if you’re flying with hungry teenagers, Swiss might be a better pick.

Yet, there is one feature of the tax code that makes Swiss residents very privileged. I would even say: unfairly privileged. This feature is: capital gains tax exemption.

What is capital gains tax?

Say that you buy a stock for 100 francs and sell it for 150. You’ve made 50 francs in capital gains! Almost all countries levy a tax on those gains. Some countries add the capital gains to your income and charge regular income tax while other use a separate rate. France, for instance, charges a flat 30% rate on all capital gains. So if you made 50 francs, you would be be able to keep 35.

Here is an overview of the capital gains tax rates of different countries.

But Switzerland is one of the few countries in the world to charge 0%!

A significant difference

To understand how truly amazing that is, I should probably tell you that, in Switzerland, investment income is taxed at your income tax marginal rate. Investment income, that’s essentially dividends.

Imagine a company returning all of its profits as dividends to shareholders. Imagine that they pay 12% dividend. Let’s assume that since they don’t reinvest nor accumulate any profit, the share price stays flat. Tracy, a Swiss resident investing 10k in this company will collect every year a 1,200 francs check as dividends. Assuming a 33% marginal tax rate, she will get to keep 800 francs. After 10 years, she has earned a net 8,000 francs and still has her shares worth 10k. Pretty cool.

Now let’s imagine that Tracy invests her 10k in a company keeping all its profits on their balance sheet. That means: they are not reinvesting their profits but they are not distributing them either. The value of the share increases every year by the amount of cash on the balance sheet. After 10 years, the shares are worth 22k. Should Tracy decide to sell 12k worth of shares, she would pay absolutely no taxes on them!

So Tracy could earn 8,000 by investing in a distributing company or 12,000 in a hoarding company. The two companies are the same: they earn the same amount of money. But by choosing one over the other, Tracy multiplies her gains by 50%! If she had a lower margin tax rate, the difference would be smaller but still significant.

Note that I’m not even considering the case in which the company reinvests its profits. 10k compounding at 12% for 10 years would make 31k, so 21k of gains, again, tax free!

What does it mean?

It means that in Switzerland, investing for dividends does not make sense. Because dividends are taxed while investment gains aren’t.

I’m convinced that this feature actually gives Swiss investors an edge over the rest of the market. Consider this: the market is projecting profits and cash flows under the assumption that both dividends and capital gains are taxed. If capital gains weren’t taxed anywhere, companies that don’t distribute a dividend would be valued at a premium (because of the calculation above). But capital gains ARE taxed almost everywhere, so this premium doesn’t exist. So Swiss investors get to buy those companies at a relative discount. Does that make sense?

Of course, dividend distribution shouldn’t disqualify a company from entering your portfolio but for me personally, it’s a serious drawback, especially if the portion of their profits distributed as dividends is significative (which means that they don’t have a lot of money left to grow).

The same way: it’s not because a company is hoarding its profits that you should definitely own it.

A personal example to conclude: Amazon famously doesn’t distribute a dividend. Yet I don’t own a single share of the company because I share the view that Amazon, is a charitable organization being run by elements of the investment community for the benefit of consumers.

But I do own shares of Johnson&Johnson which is THE company par excellence for dividend investors.

So dividends are one factor among many when picking stocks. But for Swiss investors, it’s a very significant one.