Author Topic: Earn an extra 0.5% on your investments  (Read 3504 times)

Montecarlo

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Earn an extra 0.5% on your investments
« on: January 19, 2019, 02:58:21 PM »
[Edit - if you don't want to read the vigorous debate below, there are a few things my analysis did not take into account.  One is the diminishing returns of this strategy over time.  Two is the lower cost basis for new positions takes away a good chunk of the benefits.  Three is the median stock well underperforms the average stock.  While it was an interesting exercise overall, my conclusion has changed.  I believe it is a bad idea overall.  The original posting continues unedited]


First off - this advice is NOT for everyone.

How to earn an extra 0.5%

The key is to ditch the index funds and buy individual stocks.  Yes, I said it and I'll say it again.  Ditch the index funds and buy individual stocks.

Why?

If you have a basket of stocks, even on good years with +ROI, you will have some losers and you can tax loss harvest the losers.

Let's say:
  • 40K in taxable income
  • 50 stocks
  • 35 stocks gained 15%
  • 15 stocks lost average of 10%
  • Overall portfolio gained 7.5%

Harvesting those losses nets you an additional 0.32% gain.  If you have 120K in taxable income, it goes up to 0.76%.  Pretty neat!  The more polarized your winners and losers are, the better the strategy works.

You should buy index funds instead, because you'll be more diversified
Meh.  Index funds on cap weighted indexes aren't as diversified as you might think.  Their return is more based on how the biggest companies do.  Regardless, you should only do this if you have enough capital to buy enough stocks to diversify.

You should buy index funds because of low/no management fees.
At $5K a position and $7 a trade, the tax advantage of the harvesting well outweighs the 0.14% commission you're paying, and since most of your winners you'll hold on to for multiple years, that 0.14% gets amortized away pretty fast.  Regardless, you should only do with if you have enough capital to buy enough stocks to diversify and big enough positions that the commission fee is negligable.


Stocks already are discounted so you can't beat the market by stock picking
Even if I accept this is true (I don't), you can still use this strategy by throwing darts at a wall of stock tickers.  The goal isn't to maximize alpha (though that would be nice) but to get an edge with the taxes.
« Last Edit: January 21, 2019, 05:53:09 PM by Montecarlo »

ILikeDividends

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Re: Earn an extra 0.5% on your investments
« Reply #1 on: January 19, 2019, 03:35:35 PM »
First off - this advice is NOT for everyone anyone.
Fixed that for you.

LAGuy

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Re: Earn an extra 0.5% on your investments
« Reply #2 on: January 19, 2019, 04:46:02 PM »
A couple of things. 1) Not useful for money in retirement accounts (the place where most of the people here have their money). 2) Not useful unless you're at least in a moderately higher tax bracket (most people already FIRE'd probably don't qualify). 3) Tax harvesting is overrated since all you're really doing is pushing your potential tax bill down the road. 4) Tax harvesting just isn't really worth the time unless you've got at least a million dollars in taxable brokerage accounts.

BTDretire

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Re: Earn an extra 0.5% on your investments
« Reply #3 on: January 19, 2019, 04:58:14 PM »
The concept is OK, the realization is a nightmare.
First off, this would be in taxable accounts, to take advantage of selling losses.
If you could actually match the Total Stock Market Index, and then sell losers and winners,
(that you have held for one year) then you would need to buy them all back after 30 days, and hope the market hasn't had 4% or 6% increase while you didn't own ithose stocks.

There are really just a few amounts of days in the market when you make your growth.


Per an analysis by Calamos Investments, $10,000 invested in the S&P 500 SPX, +1.32%   at the start of 1996 would’ve grown to $43,930 by the end of 2016, assuming the investor took a buy-and-hold strategy.

Miss the five best days of that period, however, and the amount you’re left with shrinks by more than a third, to $29,145, which represents annualized gains of 5.99% from the initial $10,000. The more “best days” you’re not invested for, the worse off the end result looks. If you missed the top 30 sessions of that 20-year period, in fact, you would’ve lost money, with your initial $10,000 investment shrinking to a little over $9,000.
Source: https://www.marketwatch.com/story/think-you-can-time-the-stock-market-look-at-this-chart-first-2017-12-08

 

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #4 on: January 19, 2019, 05:15:30 PM »

The concept is OK, the realization is a nightmare.
First off, this would be in taxable accounts, to take advantage of selling losses.
If you could actually match the Total Stock Market Index, and then sell losers and winners,
(that you have held for one year) then you would need to buy them all back after 30 days, and hope the market hasn't had 4% or 6% increase while you didn't own ithose stocks.

There are really just a few amounts of days in the market when you make your growth.


Per an analysis by Calamos Investments, $10,000 invested in the S&P 500 SPX, +1.32%   at the start of 1996 would’ve grown to $43,930 by the end of 2016, assuming the investor took a buy-and-hold strategy.

Miss the five best days of that period, however, and the amount you’re left with shrinks by more than a third, to $29,145, which represents annualized gains of 5.99% from the initial $10,000. The more “best days” you’re not invested for, the worse off the end result looks. If you missed the top 30 sessions of that 20-year period, in fact, you would’ve lost money, with your initial $10,000 investment shrinking to a little over $9,000.
Source: https://www.marketwatch.com/story/think-you-can-time-the-stock-market-look-at-this-chart-first-2017-12-08

 

If you're in accumulation mode, the idea would be to purchase different stocks than the ones you sold.  You give up zero time in market and don't have to worry about wash sales.

If you're in distribution mode, the losers would be the first ones to go.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #5 on: January 19, 2019, 05:22:28 PM »
3) Tax harvesting is overrated since all you're really doing is pushing your potential tax bill down the road.

I'd like to see some support for that.  My analysis has convinced me of the opposite.

BTDretire

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Re: Earn an extra 0.5% on your investments
« Reply #6 on: January 19, 2019, 05:26:59 PM »

The concept is OK, the realization is a nightmare.
First off, this would be in taxable accounts, to take advantage of selling losses.
If you could actually match the Total Stock Market Index, and then sell losers and winners,
(that you have held for one year) then you would need to buy them all back after 30 days, and hope the market hasn't had 4% or 6% increase while you didn't own ithose stocks.

There are really just a few amounts of days in the market when you make your growth.


Per an analysis by Calamos Investments, $10,000 invested in the S&P 500 SPX, +1.32%   at the start of 1996 would’ve grown to $43,930 by the end of 2016, assuming the investor took a buy-and-hold strategy.

Miss the five best days of that period, however, and the amount you’re left with shrinks by more than a third, to $29,145, which represents annualized gains of 5.99% from the initial $10,000. The more “best days” you’re not invested for, the worse off the end result looks. If you missed the top 30 sessions of that 20-year period, in fact, you would’ve lost money, with your initial $10,000 investment shrinking to a little over $9,000.
Source: https://www.marketwatch.com/story/think-you-can-time-the-stock-market-look-at-this-chart-first-2017-12-08

 

If you're in accumulation mode, the idea would be to purchase different stocks than the ones you sold.  You give up zero time in market and don't have to worry about wash sales.

If you're in distribution mode, the losers would be the first ones to go.
And now you are researching stocks that are similar but not “substantially identical”
to replace a stock that matched the Total Stock Market Index.
  Most of us have no interest in researching stocks and trying to find that not “substantially identical” stock to replace what we sold.
 Like I said, in concept OK, just more work that I'm not interested in.

PDXTabs

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Re: Earn an extra 0.5% on your investments
« Reply #7 on: January 19, 2019, 05:29:12 PM »
Tax harvesting is overrated since all you're really doing is pushing your potential tax bill down the road.

Say what? I don't endorse the OP's plan, but tax loss harvesting lets you directly cancel out capital gains as well as ordinary income. You are not "pushing your potential tax bill down the road."

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #8 on: January 19, 2019, 05:40:34 PM »

 And now you are researching stocks that are similar but not “substantially identical”
to replace a stock that matched the Total Stock Market Index.
  Most of us have no interest in researching stocks and trying to find that not “substantially identical” stock to replace what we sold.
 Like I said, in concept OK, just more work that I'm not interested in.

Why would you try to match the Total Stock Market Index?  Sounds like an effort in futility.

DreamFIRE

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Re: Earn an extra 0.5% on your investments
« Reply #9 on: January 19, 2019, 05:57:43 PM »

LAGuy

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Re: Earn an extra 0.5% on your investments
« Reply #10 on: January 19, 2019, 06:24:12 PM »
Tax harvesting is overrated since all you're really doing is pushing your potential tax bill down the road.

Say what? I don't endorse the OP's plan, but tax loss harvesting lets you directly cancel out capital gains as well as ordinary income. You are not "pushing your potential tax bill down the road."

All that tax loss harvesting does is reset the price you paid for your shares. You get a tax break today, for a higher potential tax liability down the road. Presumably one day you're going to want to sell your newly appreciated shares and you'll owe the taxes from the new lower basis. Unless you just plan to lose money forever on the shares.

PDXTabs

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Re: Earn an extra 0.5% on your investments
« Reply #11 on: January 19, 2019, 06:52:54 PM »
All that tax loss harvesting does is reset the price you paid for your shares. You get a tax break today, for a higher potential tax liability down the road. Presumably one day you're going to want to sell your newly appreciated shares and you'll owe the taxes from the new lower basis. Unless you just plan to lose money forever on the shares.

I disagree, because you also get to sell some appreciated shares and reset their cost basis higher. Also, that day in the future may never come. If I take a $3K loss, offset my ordinary income, and then die before I sell my taxable shares then my kids get a new cost basis and I was able to save more by not paying taxes on $3K of my ordinary income. Also, at least for me I fully plan for my retirement marginal tax bracket to be lower than my current tax bracket.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #12 on: January 19, 2019, 07:28:02 PM »

All that tax loss harvesting does is reset the price you paid for your shares. You get a tax break today, for a higher potential tax liability down the road. Presumably one day you're going to want to sell your newly appreciated shares and you'll owe the taxes from the new lower basis. Unless you just plan to lose money forever on the shares.
That's a decent point, except:

  • If you're accumulating, you likely have a top marginal rate of higher than 15%, so you get the arbitrage between that and 15%
  • If you're distributing, you are using the sales to live on, and there is no lower cost basis.  Just offsets of any taxes you may owe.

LAGuy

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Re: Earn an extra 0.5% on your investments
« Reply #13 on: January 19, 2019, 07:43:26 PM »
All that tax loss harvesting does is reset the price you paid for your shares. You get a tax break today, for a higher potential tax liability down the road. Presumably one day you're going to want to sell your newly appreciated shares and you'll owe the taxes from the new lower basis. Unless you just plan to lose money forever on the shares.

I disagree, because you also get to sell some appreciated shares and reset their cost basis higher. Also, that day in the future may never come. If I take a $3K loss, offset my ordinary income, and then die before I sell my taxable shares then my kids get a new cost basis and I was able to save more by not paying taxes on $3K of my ordinary income. Also, at least for me I fully plan for my retirement marginal tax bracket to be lower than my current tax bracket.

You shouldn't have anything left in your taxable account at death unless you FIRE'd with nothing in retirement accounts (not really the case for the vast majority of the readers here). Taxable account money should be spent first. Selling appreciated shares doesn't do anything except cancel out the tax benefit of a tax loss sell. There's zero reason you should be doing that (selling winners) during the accumulation years. And during your FIRE years you should be paying little to nothing in capital gains taxes anyways.

PDXTabs

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Re: Earn an extra 0.5% on your investments
« Reply #14 on: January 19, 2019, 07:52:20 PM »
There's zero reason you should be doing that (selling winners) during the accumulation years. And during your FIRE years you should be paying little to nothing in capital gains taxes anyways.

So by your own logic it would seem like a good idea for me to offset $3K/yr of ordinary income so that I can accumulate more, right?

Also, I have no idea when I am going to die. My father died while still accumulating because sometimes life sucks.

EDITed to add - not that I will, I'm too lazy to do what the OP suggests and right now almost all of my holdings are in tax deferred retirement accounts.
« Last Edit: January 19, 2019, 07:54:43 PM by PDXTabs »

LAGuy

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Re: Earn an extra 0.5% on your investments
« Reply #15 on: January 19, 2019, 07:56:59 PM »

All that tax loss harvesting does is reset the price you paid for your shares. You get a tax break today, for a higher potential tax liability down the road. Presumably one day you're going to want to sell your newly appreciated shares and you'll owe the taxes from the new lower basis. Unless you just plan to lose money forever on the shares.
That's a decent point, except:

  • If you're accumulating, you likely have a top marginal rate of higher than 15%, so you get the arbitrage between that and 15%
  • If you're distributing, you are using the sales to live on, and there is no lower cost basis.  Just offsets of any taxes you may owe.

You're not wrong. But what you're failing to miss is how people actually save and is this strategy worth their time. Most accumulators are probably maxing out their retirement accounts first. What's left goes into their taxable accounts. It's not a ton of money, and since the stock market generally goes up, there's only going to be limited opportunities to tax loss harvest on small investments. The other way they may have a significant amount of money in their taxable accounts is through some sort of windfall - inheritance or coastal home equity cash out. In that case, they may very well be done working anyways and the opportunity to tax loss off of a higher marginal never occurred.

In short, who exactly is this strategy for? Who has a significant amount of money (millions) in their taxable accounts that isn't already FIRE'd or part of the wealthy upper class to make this worth their time to do? Because it's not worth doing this on a few 10's of thousands of dollars of investments to save a couple hundred bucks. You're better off spending your time mowing lawns for the hourly return you're going to get.

LAGuy

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Re: Earn an extra 0.5% on your investments
« Reply #16 on: January 19, 2019, 08:04:45 PM »
There's zero reason you should be doing that (selling winners) during the accumulation years. And during your FIRE years you should be paying little to nothing in capital gains taxes anyways.

So by your own logic it would seem like a good idea for me to offset $3K/yr of ordinary income so that I can accumulate more, right?

Also, I have no idea when I am going to die. My father died while still accumulating because sometimes life sucks.

EDITed to add - not that I will, I'm too lazy to do what the OP suggests and right now almost all of my holdings are in tax deferred retirement accounts.

If you're working, absolutely offsetting ordinary income with a loss is absolutely what you'd want to do.

Were you to die prematurely, presumably the amount you've accumulated in your taxable accounts isn't really a significant amount. In that case, you'd be relying more on insurance to see to the needs of your children than the couple of hundred bucks you managed to save through tax loss harvesting.

Your final note really hits to the heart of the matter. Your current situation is no doubt the situation that the vast majority of MMM readers find themselves. While the strategy as presented has merits, who exactly is in a position to take advantage of it?

Andy R

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Re: Earn an extra 0.5% on your investments
« Reply #17 on: January 19, 2019, 08:43:23 PM »
First off - this advice is NOT for everyone anyone.
Fixed that for you.

+1

Most ridiculous post I have seen on here in a while.

jacoavluha

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Re: Earn an extra 0.5% on your investments
« Reply #18 on: January 19, 2019, 11:05:15 PM »
It is said that diversification is the only free lunch in investing. Picking stocks is uncompensated risk.

MustacheAndaHalf

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Re: Earn an extra 0.5% on your investments
« Reply #19 on: January 20, 2019, 05:01:16 AM »
All that tax loss harvesting does is reset the price you paid for your shares. You get a tax break today, for a higher potential tax liability down the road. Presumably one day you're going to want to sell your newly appreciated shares and you'll owe the taxes from the new lower basis. Unless you just plan to lose money forever on the shares.

I disagree, because you also get to sell some appreciated shares and reset their cost basis higher. Also, that day in the future may never come. If I take a $3K loss, offset my ordinary income, and then die before I sell my taxable shares then my kids get a new cost basis and I was able to save more by not paying taxes on $3K of my ordinary income. Also, at least for me I fully plan for my retirement marginal tax bracket to be lower than my current tax bracket.
Unlikely situations do not prove a point.  The goal here is retirement.  Most people retire.  Pretending that withdrawals don't happen ignores both the goal, and the most likely scenario.

So the OP's suggestion is actually to get a free 0.32% loan, make money on it, and then repay it.  Since you only keep the after-tax gains on that loan, it's actually a much smaller benefit than OP claims.


MustacheAndaHalf

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Re: Earn an extra 0.5% on your investments
« Reply #20 on: January 20, 2019, 05:11:28 AM »
Harvesting those losses nets you an additional 0.32% gain.
...
At $5K a position and $7 a trade, the tax advantage of the harvesting well outweighs the 0.14% commission you're paying, and since most of your winners you'll hold on to for multiple years, that 0.14% gets amortized away pretty fast.  Regardless, you should only do with if you have enough capital to buy enough stocks to diversify and big enough positions that the commission fee is negligable.
You don't gain 0.32%, the IRS loans you 0.32% until you pay it back.  The goal is retirement, at which point you start selling appreciated assets and paying tax.  So the benefit isn't 0.32%, it's the gains you make (after tax) on that 0.32%.

And that assumes 15% of your assets lose -10% and are taxed at 22%.  Most people have held stocks more than a year, which means a capital loss taxed at -15%, not their top tax rate.

What happens after a few years?  After a stock or fund has gone up +50%, what's the chance it drops enough to realize a loss?  Tax loss harvesting only works at first... once your assets have all doubled, there isn't much that can wipe away those gains and allow a taxable loss.

And all this assumes you replicate the S&P 500 with a $5,000 allocation to each stock, for a total portfolio of $250,000.  Which means you lack international, which reduces your diversification.  Plus international had some losses last year, so someone indexing could have taxable losses while you don't.  They could beat your tax loss harvesting while paying $0/trade.

Also, if you actually sell within 1 year, that's one purchase ($7 of $5,000) and one sell (another $7 of $5,000) plus then you have to reinvest in something else ($7 of $5,000).  So all told, you're looking at 0.42% commissions, not 0.14%.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #21 on: January 20, 2019, 06:06:03 AM »
Harvesting those losses nets you an additional 0.32% gain.
...
At $5K a position and $7 a trade, the tax advantage of the harvesting well outweighs the 0.14% commission you're paying, and since most of your winners you'll hold on to for multiple years, that 0.14% gets amortized away pretty fast.  Regardless, you should only do with if you have enough capital to buy enough stocks to diversify and big enough positions that the commission fee is negligable.
You don't gain 0.32%, the IRS loans you 0.32% until you pay it back.  The goal is retirement, at which point you start selling appreciated assets and paying tax.  So the benefit isn't 0.32%, it's the gains you make (after tax) on that 0.32%.

And that assumes 15% of your assets lose -10% and are taxed at 22%.  Most people have held stocks more than a year, which means a capital loss taxed at -15%, not their top tax rate.

What happens after a few years?  After a stock or fund has gone up +50%, what's the chance it drops enough to realize a loss?  Tax loss harvesting only works at first... once your assets have all doubled, there isn't much that can wipe away those gains and allow a taxable loss.

And all this assumes you replicate the S&P 500 with a $5,000 allocation to each stock, for a total portfolio of $250,000.  Which means you lack international, which reduces your diversification.  Plus international had some losses last year, so someone indexing could have taxable losses while you don't.  They could beat your tax loss harvesting while paying $0/trade.

Also, if you actually sell within 1 year, that's one purchase ($7 of $5,000) and one sell (another $7 of $5,000) plus then you have to reinvest in something else ($7 of $5,000).  So all told, you're looking at 0.42% commissions, not 0.14%.

Well this post has so many misconceptions I have to tackle them 1 by 1

"You don't gain 0.32%, the IRS loans you 0.32% until you pay it back.  The goal is retirement, at which point you start selling appreciated assets and paying tax.  So the benefit isn't 0.32%, it's the gains you make (after tax) on that 0.32%.

And that assumes 15% of your assets lose -10% and are taxed at 22%.  Most people have held stocks more than a year, which means a capital loss taxed at -15%, not their top tax rate."

If you're accumulating, you're only selling losers.  You're not offsetting with long term capital gains, you're offsetting with ordinary income.  No way is this a loan.

"What happens after a few years?  After a stock or fund has gone up +50%, what's the chance it drops enough to realize a loss?  Tax loss harvesting only works at first... once your assets have all doubled, there isn't much that can wipe away those gains and allow a taxable loss."

When you're accumulating over your working life, you will have new losers every year. 

"And all this assumes you replicate the S&P 500 with a $5,000 allocation to each stock, for a total portfolio of $250,000. "

No, why would you want to do that?  20 or so stocks should be fine for diversification.

"Which means you lack international, which reduces your diversification.  Plus international had some losses last year, so someone indexing could have taxable losses while you don't.  They could beat your tax loss harvesting while paying $0/trade."

Why can't you buy international with my strategy??  And what does last year have to do with anything?

"Also, if you actually sell within 1 year, that's one purchase ($7 of $5,000) and one sell (another $7 of $5,000) plus then you have to reinvest in something else ($7 of $5,000).  So all told, you're looking at 0.42% commissions, not 0.14%."

That's more than offset by the winners in the account you hold for 20 years, which would be $0.35/year for that commission.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #22 on: January 20, 2019, 06:12:44 AM »

In short, who exactly is this strategy for? Who has a significant amount of money (millions) in their taxable accounts that isn't already FIRE'd or part of the wealthy upper class to make this worth their time to do? Because it's not worth doing this on a few 10's of thousands of dollars of investments to save a couple hundred bucks. You're better off spending your time mowing lawns for the hourly return you're going to get.

For those who want to retire in their 30s or 40s they need significant savings in taxable accounts.  And I disagree that you need millions to make it work.  Statistically, it doesn't take an extremely high # of stocks to achieve reasonable diversification.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #23 on: January 20, 2019, 06:39:01 AM »
WAAAKE UP SHEEPLE.  Wake up altar boys at the Church of VTSAX.  You do NOT need to own the whole damn market to be diversified.  Let me repeat that.  You do not need to own the whole damn market to be diversified.  You can be diversified with as little as TEN stocks, but I would suggest twenty.


Take 10 stocks with an average return of 7% and a standard deviation of 5%.  Run those 10 stocks through 10,000 simulated years of returns.  Results:

PercentileReturn
0%1.0%
10%5.0%
20%5.7%
30%6.2%
40%6.6%
50%7.0%
60%7.4%
70%7.8%
80%8.3%
90%9.0%
100%13.8%

As you can see, it's very hard to get too far from the mean.  Add in multiple years, and the chances of seriously underperforming or outperforming the market go quickly to zero.

Edit: at a 30% standard deviation and 20 stocks, the table is roughly the same, which is why I suggest 20 instead of 10.
« Last Edit: January 20, 2019, 06:57:52 AM by Montecarlo »

Andy R

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Re: Earn an extra 0.5% on your investments
« Reply #24 on: January 20, 2019, 07:50:24 AM »
Take 10 stocks with an average return of 7% and a standard deviation of 5%.  Run those 10 stocks through 10,000 simulated years of returns. 

You are assuming you can pick 10 stocks with the average return of the market.

How do you figure you are capable of doing this? Most stocks are purchased by big institutional firms who spend tens of millions in research, and (by definition) as a whole they can not beat the market. I would go as far as to say they almost definitely know more than you which would indicate that without luck you are highly unlikely to achieve the average return of the market.

And if there was one point I would like to leave you with, it is that the Pareto principle holds true with the stock market, in that majority of the returns of the market are produced by a disproportionately small number of stocks.
By picking individual stocks, you have a far greater chance of missing some of the small number of tomorrows high performers than keeping them in.


Your original post also missed the point.

You should buy index funds instead, because you'll be more diversified
Meh.  Index funds on cap weighted indexes aren't as diversified as you might think.  Their return is more based on how the biggest companies do.  Regardless, you should only do this if you have enough capital to buy enough stocks to diversify.

The returns are not how the biggest companies "do".
The are on how the biggest companies "have done".
Subtle difference but important.
You would have had to choose them before they were so obviously proven as the ones that will "have already" done well.
Had you not picked these before they grew, you would certainly not have gotten the average return of the market.
Your argument is based on the demonstrably incorrect assumption that today's winners will be tomorrow's winners.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #25 on: January 20, 2019, 08:05:11 AM »
Take 10 stocks with an average return of 7% and a standard deviation of 5%.  Run those 10 stocks through 10,000 simulated years of returns. 

You are assuming you can pick 10 stocks with the average return of the market.

How do you figure you are capable of doing this?


I'm suggesting one random stock will beat the market 50% of the time and underperform 50% of the time.  And if you get 10 of them, you have a 50% chance of underperforming and 50% chance of overperforming, but generally you'll stay within 2% of the markets return.  You don't have to be a genius stock picker.  The point is diversification is available for a small assortment of stocks.


And if there was one point I would like to leave you with, it is that the Pareto principle holds true with the stock market, in that majority of the returns of the market are produced by a disproportionately small number of stocks.
By picking individual stocks, you have a far greater chance of missing some of the small number of tomorrows high performers than keeping them in.

That's false.  Those "studies" that show it's a small # of stocks are basing it on cap weighted indices like S&P500, where size matters.  We don't care about absolute returns, we care about relative returns.


You should buy index funds instead, because you'll be more diversified
Meh.  Index funds on cap weighted indexes aren't as diversified as you might think.  Their return is more based on how the biggest companies do.  Regardless, you should only do this if you have enough capital to buy enough stocks to diversify.

The returns are not how the biggest companies "do".
The are on how the biggest companies "have done".
Subtle difference but important.
You would have had to choose them before they were so obviously proven as the ones that will "have already" done well.
Had you not picked these before they grew, you would certainly not have gotten the average return of the market.
Your argument is based on the demonstrably incorrect assumption that today's winners will be tomorrow's winners.

That's a strawman.  I never suggested buying stocks that have gone up.  You trying to deconstruct my entire argument based on my verb conjugation is pretty hilarious. 

Maenad

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Re: Earn an extra 0.5% on your investments
« Reply #26 on: January 20, 2019, 08:13:54 AM »
WAAAKE UP SHEEPLE. 

Well, that's DEFINITELY the way to convince people to give your strategy a chance.

I mean, really. That's the argument of a child, not an adult.

Indexer

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Re: Earn an extra 0.5% on your investments
« Reply #27 on: January 20, 2019, 08:29:36 AM »
TLH:  There is a benefit, even if you need to sell the shares in the future. This is because you could reinvest the tax savings so you have more money invested between the timing of the TLH and the timing of the eventual sale.

However, when running calculations to see what the benefit would be you should assume you will sell the shares in the future, because you likely will(if on the FIRE path). When you sell those shares your basis will be lower(thanks to TLH) so you will have more gains, and thus more taxes, than if you never did the TLH. Companies that support aggressive TLH often fail to include this calculation. Betterment tells you in their fine print that they don't. It appears Montecarlo also failed to run this calculation.

Once you account for this there is a benefit of TLH, but it's normally really small. Instead of adding .77% or 1% returns(depending on the source) the number appears to be in the 0.1-0.2% range. Yes a benefit, but such a small benefit that you could likely destroy it if you...

1.Paid too much money on brokerage fees, which could likely happen with a strategy that requires excessive trading.

2. Gave up too much of your own time, which could likely happen if you are picking and managing 20 stocks. Note, every proponent of using individual stocks that I've ever read strongly recommends doing regular research on those companies to make sure they are still a good fit.

3. Made even a single emotional move. I don't mean selling in a crash, that would wipe out a lot more than 0.1%. I mean just failing to add a new contribution or rebalance when you are supposed to. Hesitating to make the logical decision could easily cost 0.1%. Why do I think using individual stocks instead of an index fund increases the odds of making emotional moves? Every source I've ever seen on the subject comes to the same conclusion that the more time you spend looking at your balances and making trades the more likely you are to make impulsive emotional decisions. Their is a behavioral benefit to using index funds.

4. Pick the wrong stocks. The vast majority of actively managed funds underperform the index funds, and they normally use 60+ stocks. You think you are going to get returns closer to the index using 20 stocks? If you underperform the index by even 0.1% you likely wasted all of the benefit you would have gained from TLH.

Plus, you can TLH with the index funds. Sure, you can only do it when the whole market moves, but even if you used 20 stocks the best TLH opportunities would be when the whole market moves. ;-)


Diversification:  I second everything Andy said.


I'm suggesting one random stock will beat the market 50% of the time and underperform 50% of the time. 

Well your assumption is wrong and your entire case is built on that assumption so... 

Over the past several years most of the returns of the market were from a minority of stocks. The median stock underperformed the market, but the few that outperform tended to outperform it by a lot. Picking those stocks is highly unreliable. If your 20 stocks... a really small sample size... didn't include a proportional number of super stars as the overall market you would see performance very different from the market. Like I said in point #4, most active funds mess this up using a lot more stocks. Why would you do better than them, keeping in mind you lack the research resources they have access to?


Edit: added another sentence about TLH.
« Last Edit: January 20, 2019, 09:23:12 AM by Indexer »

harvestbook

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Re: Earn an extra 0.5% on your investments
« Reply #28 on: January 20, 2019, 09:22:26 AM »
There's a strategy where I only win by dying? Tell me more!

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #29 on: January 20, 2019, 09:35:00 AM »
I'm suggesting one random stock will beat the market 50% of the time and underperform 50% of the time. 

Well your assumption is wrong and your entire case is built on that assumption so... 

Over the past several years most of the returns of the market were from a minority of stocks. The median stock underperformed the market, but the few that outperform tended to outperform it by a lot. Picking those stocks is highly unreliable. If your 20 stocks... a really small sample size... didn't include a proportional number of super stars as the overall market you would see performance very different from the market.

I just pulled some data and you sir have a very valid point.  The mean return of stocks is well above the median return.  Which means the mean investor who picked my strategy would be slightly better off, while the median investor would be much worse off.

So it doesn't make much sense unless you have a solid stock picking strategy, which is a highly improbable undertaking.

Travis

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Re: Earn an extra 0.5% on your investments
« Reply #30 on: January 20, 2019, 10:10:11 AM »

I'm suggesting one random stock will beat the market 50% of the time and underperform 50% of the time.  And if you get 10 of them, you have a 50% chance of underperforming and 50% chance of overperforming, but generally you'll stay within 2% of the markets return.  You don't have to be a genius stock picker.  The point is diversification is available for a small assortment of stocks.


Where did you come up with this assumption?  If your stock picks have an even chance of beating or under-performing the market, by how much are they doing so?  I see your strategy playing out in one of two scenarios: either you buy your positions weighted to the that company's market cap or you buy equal positions in your "random" stock picks. 

If you're buying by market cap, then your 50/50 performance metric will be skewed by that weight.  A collection of smaller companies would have to do double the work if one of the larger companies reacted in the opposite direction.  If you're buying equally, then you could just as easily over or under-weight the effect of that position.  That random stock could have a really bad year, but because you've equally weighted it against a stock that had a great year (and had a much larger market cap) you could both lose bigger or gain less than holding the whole index would have provided.

You could flip my examples the opposite way to try to sell your point, but this does not happen 50% of the time and you have no way to predict when this random assortment of stocks will behave this way.  You could pick a string of losers over and over again with nothing to counteract them.  That's what makes it "random."

BobTheBuilder

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Re: Earn an extra 0.5% on your investments
« Reply #31 on: January 20, 2019, 10:50:27 AM »
Fun fact: You can have the ETF benefit and the tax loss harvest benefit. The tax loss harvesting might matter more or less depending on your tax system. In Germany, you cannot do the FIRE thing with ETFs in untaxed accounts to my knowledge. To get the tax advantages, you have to tie up your money until state pension sets in at 67 and with ridiculously bureaucratic contracts that eat up a large part of your gains. Individual stocks only have the dividends taxed until you sell them.

But if you diversify your ETFs over the globe, assuming you don't pick non-growth markets like Europe or Japan (declining demographics), there is reason to assume they are going to go up at comparable rates, but on a different schedule. Look at EM or Pacific-exJapan for instance. EM is very volatile, but generally goes upwards, Pacific-exJapan is less volatile, but Australia is a free market county too and demographics are positive. Congratulations, you can now harvest tax losses to some degree. Most benefit during accumulation and depending on your tax system, as well as portfolio size.

The median vs. average is however hard to battle on a scale of only ten stocks, so I would suggest trying that with ETFs.

Also, the US had an awesome run over the last 10 years, but there where times when it did not. Who knows what the future holds. In the long run, free markets with healthy demographics should give a comparable return.

MustacheAndaHalf

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Re: Earn an extra 0.5% on your investments
« Reply #32 on: January 21, 2019, 07:49:01 AM »
...
"What happens after a few years?  After a stock or fund has gone up +50%, what's the chance it drops enough to realize a loss?  Tax loss harvesting only works at first... once your assets have all doubled, there isn't much that can wipe away those gains and allow a taxable loss."
When you're accumulating over your working life, you will have new losers every year. 
If you agree only recent money can tax loss harvest, why did you use "extra 0.5%" in the thread title?  Your tax loss harvesting will be worth a smaller and smaller percentage over time.

"Which means you lack international, which reduces your diversification.  Plus international had some losses last year, so someone indexing could have taxable losses while you don't.  They could beat your tax loss harvesting while paying $0/trade."
Why can't you buy international with my strategy??  And what does last year have to do with anything?
Because international isn't going to cost $7/trade.  Schwab charges over $20/trade for European stocks, for example.

Although you calculate gains from your approach, you don't provide any numbers for tax loss harvesting of index funds.  Assuming it is $0 is false, and last year was example of when indexing can tax loss harvest in international.

"Also, if you actually sell within 1 year, that's one purchase ($7 of $5,000) and one sell (another $7 of $5,000) plus then you have to reinvest in something else ($7 of $5,000).  So all told, you're looking at 0.42% commissions, not 0.14%."
That's more than offset by the winners in the account you hold for 20 years, which would be $0.35/year for that commission.
Earlier you said it's 0.14%, now you say it's not.  I think when you provide ideas without data, it means others have to argue against a moving target.

theoverlook

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Re: Earn an extra 0.5% on your investments
« Reply #33 on: January 21, 2019, 08:45:23 AM »
WAAAKE UP SHEEPLE.  Wake up altar boys at the Church of VTSAX.
And here's where I tuned out 100%. You want to convince someone of something, insulting them is not the way to do it.

Indexer

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Re: Earn an extra 0.5% on your investments
« Reply #34 on: January 21, 2019, 08:48:21 AM »
I'm suggesting one random stock will beat the market 50% of the time and underperform 50% of the time. 

Well your assumption is wrong and your entire case is built on that assumption so... 

Over the past several years most of the returns of the market were from a minority of stocks. The median stock underperformed the market, but the few that outperform tended to outperform it by a lot. Picking those stocks is highly unreliable. If your 20 stocks... a really small sample size... didn't include a proportional number of super stars as the overall market you would see performance very different from the market.

I just pulled some data and you sir have a very valid point.  The mean return of stocks is well above the median return.  Which means the mean investor who picked my strategy would be slightly better off, while the median investor would be much worse off.

So it doesn't make much sense unless you have a solid stock picking strategy, which is a highly improbable undertaking.

Glad I could help. I agree that while some investors could be better off, most wouldn't be. Given that, wouldn't it be more prudent to use index ETFs, which still allow you to TLH while remaining diversified?



In addition, I wish I remembered this earlier, but I believe Wealthfront(or one of the other Robos) has an automated account where they will do this for you. I haven't used it so I can't speak in detail, but my understanding is that they buy about half of the S&P 500 stocks and anytime one stock is down they switch it out for it's surrogate. Example: sell Ford & buy GM. It's like the strategy Montecarlo is describing but it uses about 250 stocks instead of 20 and an algorithm is doing all of the tedious work. If someone has used it maybe they have access to the after-tax returns and we can compare that to an SP500 index ETF like VOO. I tried searching Google but I couldn't find any return history.

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #35 on: January 21, 2019, 01:36:01 PM »
If you agree only recent money can tax loss harvest, why did you use "extra 0.5%" in the thread title?  Your tax loss harvesting will be worth a smaller and smaller percentage over time.

The time diminishing returns is a factor I hadn't considered.  Good catch!

Earlier you said it's 0.14%, now you say it's not.  I think when you provide ideas without data, it means others have to argue against a moving target.

I estimated 0.14%.  You provided an example where it's higher.  I provided an example where it's much less.  I was supporting the initial estimate, not moving the goal post. 

Montecarlo

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Re: Earn an extra 0.5% on your investments
« Reply #36 on: January 21, 2019, 05:53:58 PM »
I added this to the beginning of the original post:

[Edit - if you don't want to read the vigorous debate below, there are a few things my analysis did not take into account.  One is the diminishing returns of this strategy over time.  Two is the lower cost basis for new positions takes away a good chunk of the benefits.  Three is the median stock well underperforms the average stock.  While it was an interesting exercise overall, my conclusion has changed.  I believe it is a bad idea overall.  The original posting continues unedited]

ILikeDividends

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Re: Earn an extra 0.5% on your investments
« Reply #37 on: January 21, 2019, 05:57:35 PM »
I added this to the beginning of the original post:

[Edit - if you don't want to read the vigorous debate below, there are a few things my analysis did not take into account.  One is the diminishing returns of this strategy over time.  Two is the lower cost basis for new positions takes away a good chunk of the benefits.  Three is the median stock well underperforms the average stock.  While it was an interesting exercise overall, my conclusion has changed.  I believe it is a bad idea overall.  The original posting continues unedited]

+1