Walt, I'm glad you are considering a buy and hold strategy. I've published variants of this analysis countless times, but just to strengthen your resolve I'll do it one more time with a different set of numbers (because I do it on the fly each time).
Let's assume that we are dealing with a stock that appreciates 20% per year over the next five years and you use a buy and hold strategy. This stock will have appreciated by 148.8% by the end of five years, and using the long-term capital gains rate of 18% the investor would have realized a profit of 122% after taxes. Over the five year holding period the after-tax rate of return is 17.3% (not 16.4% which some people naively assume e.g. 0.82*0.2 =0.164). By comparison, the trader must realizes only 14.4% after taxes. So, to achieve the same results as the buy and holder, the trader must realize 24% pre-tax. This is an astounding difference, especially in view of the fact that you buy at the asked price, sell at the bid and pay transaction fees at every step of the way. To see this effect let's assume a $100,000 trading nest egg, one round trip per month at $15 each trade, and 1/4 spread between bid and asked (i.e. bid 88 3/8 asked 88 5/8).
Here are the results assuming that 20% per annum stock at an assumed price of $80 to start with: the after-tax net is reduced to 11.38% (assuming quarterly estimated tax payments).
Now, it is difficult for me to envision how TA attracts so many people given this kind of analysis. 17.3% vs. 11.4% means that the after tax return is almost 52% higher for the buy and hold investor than the trader. That implies that a substantial improvement in the pre-tax rates of return would be required to profit from a market-timing strategy to simply equal the buy and hold strategy.
If you are interested in the sensitivity, the longer the buy and hold strategy the higher the annualized effective after-tax rate. The greater the investment and the smaller the spread, the greater the after-tax return on the trading strategy. Obviously, the fewer the number of trades, the greater the return.
I guess what I'm really driving at here is that because of the magnitude of the differences, even if TA worked it would be difficult to profit from it other than finding a good buy-in.
TTFN,
CTC |
