Does reinvesting payouts in plain vanilla exchange-traded funds enhance household portfolio performance?

Hans Philipp Wanger

Abstract

A frequent recommendation to households is to invest in XTFs, ie, plain vanilla exchange-traded funds (ETFs) that replicate broad, internationally diversified market indexes. However, many households own financial assets already and are not able or willing to sell them for a switch to XTFs. This paper is, to the best of the author’s knowledge, the first to examine, as an alternative for such households, whether reinvesting payouts in XTFs enhances households’ portfolio performance (after transaction costs). Risk and return of household portfolios are estimated using representative security holding data of German households from January 2014 to June 2017. Thereby, multiple asset classes of household portfolios and several types of transaction costs are considered. The results indicate that reinvesting payouts in XTFs on average enhances households’ portfolio performance after transaction costs and that this strategy is more favorable and cost-efficient than reinvesting payouts according to households’ current portfolio composition. To obtain economically significant enhancements, however, a longer period than the three-and-a-half-year observation period is necessary. The findings suggest that reinvesting payouts in XTFs is a useful alternative strategy for households who invest for the long term, who already hold financial assets and want to switch to XTFs but are unable or unwilling to sell their current assets.