How should I invest in US equity?

Invest in a cost-effective manner. For smaller corpus, it makes sense to invest via India-domiciled mutual funds that invest overseas, while with a larger corpus it could be cheaper to invest directly

Intro ✨

Investing in US equity markets can be rewarding, if done for the right reasons, with right expectations.

When it comes to overseas investments; costs are usually the biggest factor to keep in mind. Unlike market returns, costs are in your control, and can be a determining factor in outcome of your investing journey.

There are currently two main ways in which retail Indian investors can invest in US stock market:

• Direct Investing: Investing via a platform or broker, which allows one to direct buy US stocks, ETFs, and other securities directly.

• Indirect Investing: Investing in India-domiciled mutual funds, FoFs (Fund of Fund - a mutual fund investing in another mutual fund), or ETFs (Exchange Traded Fund) which invest in US companies’ stocks.

If one is investing in smaller amounts (or SIPs) of less than ₹2L or so at a time, India-domiciled mutual funds are the more efficient choice due to lower costs (as low as 0.49% TER currently) and a simpler tax compliance process.

Explanation 📜

There are India-domiciled US index funds available to retail Indian investors at reasonable low costs.

For instance, the Motilal Oswal S&P 500 Index Fund Direct Growth (archive.org link | archive.is link), is available at a relatively reasonable TER (Total Expense Ratio) of 0.49% (as of 25 March 2021).

There are also actively managed funds starting at a sightly higher (but still pretty reasonable) TER; that offer exposures in US equity markets.

But if one were to try and invest directly, one would run into a few challenges. At present, the international fund transfer process is cumbersome and expensive. Mainly because:

• Banks typically charge ₹500 - ₹1500 for every single international fund transfer.

• There is another 1% in currency spread / forex costs on the transaction, that's incurred for every transfer.

• There is an LRS form (called the A2 form) that needs to be physically submitted and presented to the bank for international transfers for the purpose of investing. Some banks might pick up this document from your place, or allow an online submission, but it can take up to two weeks for the funds to show up in your international trading account. Which means two weeks of opportunity and interest cost.

• The same costs and time, when withdrawing the funds back to Indian bank accounts; effectively doubling all above costs.

As a result of the above fees and taxes, average retail investors might lose up to 5% of their capital even before they’ve bought a single stock.

See this comment from Zerodha (archive.org link | archive.is link) outlining the pain points for Indian investors investing in US stocks or ETFs directly.

In additional to the fund transfer process, there’s also the additional overhead of higher tax compliance when it comes to investing directly. For instance, one has to declare their directly held foreign shares under foreign assets while filing one’s ITR.

Because of the cumbersome and expensive fund transfer process and additional tax compliance, it is recommended that for now, Indian retail investors should prefer India-domiciled mutual funds and ETFs for investing in the US.

An Estimate of Fees 💱

One's fees will vary depending on the bank or service one uses, and tends to get more reasonable as a fraction of total investments the larger one’s investment amount is. As an illustration one can refer to the below table ($1 = ₹72.5):

Amount to invest	Remittance Charges + Taxes	Investible / Redeemable Amount	Broker charges - to transfer money to your Indian bank A/c ($35)	Amount credited to bank A/c	Actual Returns
₹10,000	₹600	₹9,400	₹2500	₹6,900	-31%
₹50,000	₹750	₹49,250	₹2500	₹46,750	-6.5%
₹1,00,000	₹900	₹99,100	₹2500	₹96,600	-3.4%
₹5,00,000	₹1,250	₹4,98,750	₹2500	₹4,96,250	-0.75%
₹10,00,000	₹1,700	₹9,98,300	₹2500	₹9,95,800	-0.42%

Remittance charges may vary from bank to bank. For simplicity, we’ve used the average of present remittance charges across HDFC, ICICI, and SBI. You may notice a slight difference depending on which bank you use.

The above table doesn't consider the forex conversion spread, which can be estimated as 1%.

A conversion spread means you get to buy USD from bank, at higher price than it's worth, and sell to bank at lower price, than it's worth at that time.

On the other hand, as you invest and accumulate larger and larger corpus; the proportional cost model (i.e., where you get charged a percentage of your asset size) becomes costlier.

For instance, if you're investing ₹50,00,000 (50 Lakhs INR), an effective expense ratio of 1.5% would eat away ~₹75,000 (75k INR), every year. At that corpus size, it might be cheaper to actually invest directly into a US ETF (domiciled in IRE / LUX), and incur compliance costs.

List of Direct Platforms ✔️

Types of Platforms

There are broadly, two types of platforms providing US investing services to Indians:

• An Indian brokerage or platform, having a tie-up with an international or US based-brokerage like Drivewealth or Saxo.

• An international brokerage.

The international brokerages generally require a minimum account value (total value of investments held with that broker - similar to minimum relationship value used by banks) and charge higher brokerage.

On the other hand, Indian platforms generally don’t require a minimum account value and generally have lower brokerage charges (some even offer zero brokerage).

Common Platforms

Some of the common platforms are:

• Vested (US-headquartered Indian platform)

• Winvesta (Indian platform)

• IndMoney (Indian platform)

• Groww (Indian platform)

• ICICI Direct (Indian brokerage)

• HDFC Securities (Indian brokerage)

• Interactive Brokers (International brokerage)

• Charles Schwab (International brokerage)

Aspects such as fees/charges, features and range of stocks available for investment vary from broker to broker and keeps changing over time.

For more reading, one can refer to the following reddit thread (old.reddit link | archive.is link) for a recent discussion on some of the popular options.

Tax Implications 🧾

Direct Option

When you invest in the US stock market directly, there are two types of taxation events:

• Taxes on investment gains: You will be taxed in India for this gain. Taxes will not be withheld in the US. The amount of taxes you have to pay in India depends on how long you hold the investment. The threshold for long-term capital gain is 24 months, with the rate of 20% with indexation benefit. If you sell a stock in less than 24 months, capital gains are considered short-term and are taxed according to your income tax slab.

• Taxes on dividends: Unlike investment gains, dividends will be taxed in the US, at a flat rate of 25%. Fortunately, the US and India have a DTAA (Double Taxation Avoidance Agreement) which allows taxpayers to offset income tax already paid in the US. However, availing proof and paperwork for DTAA is not straight-forward. The 25% tax you already paid in the US is made available as FTC (Foreign Tax Credit) and can be used to offset your income tax payable in India.

Indirect Option

India-domiciled mutual funds and ETFs holding more than 35% of their overall portfolio in foreign stocks are taxed similar to debt mutual funds and provide indexation benefits on long term capital gains after three years.

If held for less than 3 years, gains are added to your overall income and taxed at your income tax slab rate. If held for more than three years, gains are taxed at a flat rate of 20% after indexation.

While Indian equity funds have an advantage over international equity funds when it comes to taxation, taxation shouldn’t be the most important criteria if one is investing for long term and one is investing according to one’s asset allocation.

Also, one must keep in mind that tax rules can change over time.

Things to Keep in Mind 🧠

• Under the RBI’s LRS (Liberalized Remittance Scheme), resident Indians can invest up to USD 250,000 (~₹1.8 Cr. based on $1=₹72.5) per FY (Financial Year) for any permitted current or capital account transaction or a combination of both. Link to RBI document | archive.is link

• Investments in US equities must be made in USD. One has to first wire (remit) USD to one’s broker’s partner bank in the US to fund one’s account. In order to do this, the investor must fill out an LRS form (called the A2 form) and submit it to their own bank.

• On placing a withdrawal request, the money should be wired directly to your bank account in India. It may take 3 to 5 business days for the wire to come through.

• The Indian securities market regulator SEBI doesn’t have any effective oversight of these entities.

  Hence, as a cursory check, investors should verify that the brokerage they are investing through is registered with the SEC, FINRA and SIPC which are the primary US regulatory bodies.

  • FINRA broker check

  • SIPC list of members

• If you opt for the indirect option, some of these funds might be fund of funds. ie, the India-based MF simply buys units of another fund investing in the US markets (called the underlying fund). For instance, the Franklin India Feeder - Franklin U.S. Opportunities Fund invests in the Franklin U.S. Opportunities Fund, Class I (Acc) fund which is an international fund investing in US stocks and run by Franklin Templeton in multiple countries. Investors should note that the Total Expense Ratio (TER) shown in the factsheet of such funds usually only includes the TER of the FoF/feeder fund. The underlying fund would also have its own fees (e.g., management fees, etc). The actual expense incurred by investors will also include this and will usually be the sum of both these, i.e. Effective TER = TER of the FoF + total fees of the underlying fund To illustrate, let us look at the Franklin India Feeder - Franklin U.S. Opportunities Fund. As of 29 January 2021, its factsheet (archive.org link | archive.is link) mentions its expense ratio as 0.61% for the direct plan. But we also see that the underlying fund’s prospectus (archive.org link | archive.is link) mentions a management fee of 0.70%. So for an investor, as on 29 January 2021, the total expense charged would be at least: 0.61 + 0.70 = 1.31%

It is advisable for Indian investors to also go through the prospectus, factsheet or other such scheme documents of the underlying fund to get a better idea of any hidden fees and charges.