In recent years, investing in Exchange-Traded Funds (ETFs) has gained significant popularity, thanks to the simplicity and diversity they offer. When investing in ETFs, one crucial aspect to consider is the type of returns they provide. This is where Total Return (TR) and Price Return (PR) ETFs come into play. In this blog, we’ll explore the differences between TR and PR ETFs and how to make the best use of them.
What is an ETF?
Before delving into TR and PR ETFs, let’s briefly recap what an ETF is. An ETF is an investment fund that holds a variety of assets such as stocks, bonds, commodities, with the goal of tracking the performance of a specific index, sector, or asset class. ETFs are traded on stock exchanges, allowing investors to buy or sell them at market prices throughout the trading day.
Understanding Price Return (PR) ETF
PR ETFs are one of the most common types of ETFs. They track the price movements of their underlying assets, considering dividends, interest, and other income generated by these assets.
Advantages of PR ETFs:
- Simplicity: PR ETFs are straightforward and suitable for investors who prefer an intuitive, basic investment approach.
- Low Costs: These ETFs typically have lower expenses due to their straightforward tracking methodology.
Disadvantages of PR ETFs:
- Lower Long-Term Growth: Over time, excluding reinvested dividends may result in lower growth rates compared to TR ETFs.
Understanding Total Return (TR) ETF
TR ETFs provide a more comprehensive approach by reinvesting all dividends, interest, and capital gains to replicate the total return of an index or asset class.
Advantages of TR ETFs:
- Enhanced Long-Term Growth: Reinvesting income can enhance long-term performance.
Disadvantages of TR ETFs:
- Complexity: TR ETFs may be challenging to understand due to the reinvestment of income, making them less suitable for some investors.
- Slightly Higher Costs: These ETFs can have slightly higher expense ratios due to their more complex structure.
| | TIGER US S&P500 | KODEX US S&P500TR |
| Market Cap (As of Now) | $14.6b | $4.5b |
| Fee | 0.07% | 0.05% |
| Other Fees | 0.3769% | 0.1290% |
| Total Fee (Annual) | 0.4469% | 0.1790% |
| Dividend Rate (Estimated) | 1.5% | 0% |
A Case Study: PR & TR S&P 500 ETFs
So, let’s take a look at a case study. We’ll compare the advantages and disadvantages as well as the future performance of the largest PR & TR S&P 500 ETFs in South Korea. If you’re investing from a pension account, the dividends distributed through PR ETF investments aren’t immediately taxable, which makes them no different from TR ETFs. Therefore, this case study is focused on investments made in regular accounts.
- Principle (Annual) : 9M KRW
- Investment Period : 30 Years
- CAGR : 6% (PR) / 7.5% (TR)
- Dividend Rate (Annual) : 1.5%
- Dividend Income Tax : 15.4%
| | 10y | 20y | 30y |
| Cumulative Principle | 90 | 180 | 270 |
| Appraised Value | 126 | 351 | 754 |
| Cumulative Dividend | 9.5 | 45 | 128 |
| Cumulative Dividend Income Tax | 1.4 | 7 | 20 |
| Net Total | 133 | 389 | 862 |
[TR]
| 구분 | 10y | 20y | 30y |
| Cumulative Principle | 90 | 180 | 270 |
| Appraised Value | 137 | 419 | 1,000 |
| Cumulative Dividend | – | – | – |
| Cumulative Dividend Income Tax | – | – | – |
| Net Total | 137 | 419 | 1,000 |
(Unit : Million KRW)
*Net Cumulative Evaluation Amount (PR= Cumulative Evaluation Amount + Dividends – Dividend Income Tax, TR= Cumulative Evaluation Amount)
In general, since you’re not paying dividend income tax and investing 100% in the fund, it’s evident that TR ETFs would yield better results. However, to understand how much dividend income tax (tax) impacts long-term investments, a simulation was conducted. It was found that after 10 years, it impacts by 2.3%, after 20 years by 7.6%, and after 30 years by up to 16.0% on total returns. Of course, this simulation is based on a simple annual compounding average return rate and doesn’t consider short-term fluctuations. As explained in a previous post, for investments longer than 10 years, fluctuations are generally absorbed, so results after 10 years can be observed without significant concern.
However, in a regular account, when investing in domestically listed overseas ETFs (or any ETF other than domestic ETFs), if you make a profit of over KRW 20 million from trading, it’s subject to comprehensive income taxation. The actual post-tax difference % may decrease based on factors like the timeframe of trading, the amount traded, other sources of income from employment/business/other, and more. Ignoring these factors might lead to unexpected tax liabilities. This is why tax-advantaged accounts like pension and ISA accounts are advantageous.
In conclusion, the choice of ETF type depends on your investment goals, risk tolerance, and understanding of the funds. If you prefer simplicity and regular dividends and have a focus on short-term investments, PR ETFs seem to be a good choice. If you can handle the complexity of reinvesting income and are aiming for high long-term returns, then TR ETFs might be the better option. I’m pursuing long-term investments (20-30 years) and finds dividend reinvestment in TR ETFs bothersome, so I have opted for TR ETFs. Of course, these investments are made within both pension and ISA accounts.
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