Germany boasts a dynamic investment culture and investment products can range in quality. It is recommended that investors treat the decision to invest in Germany with caution and are wary of their investments. One approach is through an automated investment platform. Whilst the ownership of assets remains with the investor, the platform can automatically pay dividends from funds, bonds and shares. The main advantage of using a platform for German investments is in the comparatively low associated annual cost.
Whilst most German financial companies are unwilling to allow American citizens to make investments in funds, bonds and stocks due to the potential penalties which can be incurred, American citizens can still do so through platform which adheres to IRS regulations by providing income reports. Nowadays, various investment platforms which are available to German-resident American investors.
The traditional route to investing in Germany has been through products offered by commercial and savings banks; however, this approach comes with a high level of risk due to the sales-orientated manner in which the banks operate. Additionally, German banks operate with only a minimal level of regulatory oversight and investors are only safeguarded by extremely basic consumer protection legislation. Moreover, the career progression of customer-facing bank employees is typically dependent upon their ability to sell financial products; this must be kept in mind when investing. The selection of investment products which banks have available is usually limited to their own products, or to specific products from other investment providers. Unfortunately, the sale of a particular financial product is rarely matched to individual client need. Additionally, disinvesting in products can be a prolonged and costly process and when required, German banks can usually afford a higher-quality and more expensive legal team than an investor can.
In Germany, it is common for a bank to recommend the extension of a particular loan to increase a client’s investment in their own fund products, when their credit rating allows this. However, the disadvantage is that the risk is borne by the investor, not the bank; it may be more appropriate to instead use available funds, as a leveraged position will incur quicker losses than simply using available funds. It must also be kept in mind that in Germany, investment advisers may show a bias towards a particular single fund company or KAG, which may occur due to an emotional bias, or a legal requirement, and will recommend products to a client on that basis.
The amount of front-end fees which are paid to the investment adviser also usually influences the recommendation. There are circumstances in which this is not a drawback for an investor, such as when the investor has a specific idea of a particular stock, bond or fund which they would like to invest in, but this can be a disadvantage when fully independent advice is required. Investors should remember that consumer and investor protection legislation is less rigorous in Germany than in other countries, and investors may be given factually incorrect information, and investments may not be beneficial in the long run.
When an investor visits a fully-independent adviser, it is usual practice for the adviser to assess the ability and level of risk-tolerance of the investor, through a mixture of both quantitative and qualitative approaches, to identify investments matched to the investor’s need and profile. It is best practice for the adviser to generate and provide a written report outlining their recommendations, and reasons for doing so. If an adviser is unwilling to provide such a report, investors should strongly consider using another independent adviser.
Investors should be wary of popular products in Germany, and particularly the Riester, Rürup and Basis-Rente product range. These are frequently recommended as being effective tax-saving vehicles, but these products are actually long-term pension products which lock in the funds until an investor reaches 60 years of age. A further disadvantage of these products is that should a foreign investor need to leave Germany, the funds are not portable and must be left behind to accumulate until maturity, and will only then be paid as a lifetime annuity.
Potential investment products
There are a range of German investment products and the suitability of a particular product can be matched to the temperament of an investor. Investment markets tend to be suitable for long-term investors, as a time period of less than three years can expose an investor to the risk of falling between adverse market cycles. It is not recommended for individuals to risk incurring capital losses in a short investment time horizon.
The following products are ordered, from the lowest to the highest level of risk:
- A cash savings plan, or a bank deposit, where the bank is backed by a government guarantee scheme.
- A guaranteed pension plan, or insurance company deposit.
- Mutual or investment funds, which are assigned a risk category ranging from Risk Category 1 (denoting the lowest level of risk) to 5 (a very high level of risk and volatility)
- Closed-ended funds (Geschlossene Fonds), which operate on the basis of a finite maturity date and frequently have a high risk level. However, German legislation has recently been updated and investors must now be supplied with an up-to-date prospectus, detailing the specific risks and opportunities of the fund.. Normally, an investor will be required to sign a declaration to signify that they have received and have read the prospectus, and that they clearly understand the risk level. Whilst the structure of content of all prospectuses must be approved by BaFin (the German authorities), investors should bear in mind that this does not extend to the fund viability or potential performance.
- Investing directly in German Government-subsidised projects on a long-term basis
- Residential property investments
- Certificates or instruments which use derivatives to track market or indice movements (Zertifikate)
- Private equity investments or hedge funds.
In Germany, gradual changes made by successive governments, have closed many of the existing tax loopholes. Whilst these changes can be retroactive, a lengthy notice period is normally provided. However, there have been problems with the interpretation of such changes and it has been necessary for the court system to act as the final arbiter of the tax changes.
Germany introduced an investment tax of 25% on 1 January 2009, which includes capital gains and investment income, from this date. Whilst a range of new products were introduced to accompany the tax, the response from investors was unenthusiastic due to the ongoing economic crisis, since the values of the portfolios held by investors had dropped so low that the prospect of capital gains were unrealistic. All new investments are affected by the new tax.
Individuals and married couples benefit from a respective 801 and 1,602 Euro tax allowance applied to interest and investment income. Whilst this can be divided between institutions, attempts to exceed the allowance are strongly discouraged due to the severe penalties applied. It is recommended that foreign investors, who are considering investing in German markets, consult a tax specialist before doing so, as there are very few exceptions to the general lack of tax-sparing schemes. For example, Germany does operate double taxation agreements with several other countries, which may be beneficial under certain circumstances. Tax consultants are wary of their possible professional liability and will generally not give an opinion on the economic viability of a particular situation, but can confirm or deny the particular tax consequences of an investment.
Principles of German Investments
- Complex schemes with multiple products are not designed in the best interests of an investor and should be viewed with suspicion.
- If an investment scheme seems too good to be true, it probably is: German legislation does not extend to promises of abnormally high returns made to investors.
- Be wary of vague claims regarding investment returns: the phrase ‘chance auf’ is frequently followed by an high percentage yield; such yields are rarely achieved.
- A financially conservative approach is beneficial.
- Independent advisers should always be consulted and must provide copies of all documentation, which should include a record, and risk analysis, of your particular needs and instructions, an up-to-date prospectus and copies of application forms. These will be needed should any subsequent disputes occur.
- Investors should be aware of their mandatory two-week cooling-off period after signing an application form, and exercise this right if necessary.
- Spread your investment risks and irrespective of the product, never have 10% or more of your portfolio invested in one fund or strategy.
- Remember, any guarantees made are only as good as the issuing company.