The greatest trader ever vs. buy and hold

[sirdoug007]

Saw this article today on reformed broker: http://www.thereformedbroker.com/2014/07/09/lets-say-youre-the-best-trader-ever/

It's absolutely astounding the impact short term capital gain taxes have here!  I would never have thought that you could totally erase a 40% outperformance through taxes.

Just think about how bad your returns are when you realize you are NOT the best trader that ever walked the earth!

[hodedofome]

Tax rates are different for everyone, but for sure they can eat into returns. There are always tax-protected accounts, and off-shore LLCs if you have the $$$. Where there's a will, there's a lawyer.

[arebelspy]

Saw this article today on reformed broker: http://www.thereformedbroker.com/2014/07/09/lets-say-youre-the-best-trader-ever/

It's absolutely astounding the impact short term capital gain taxes have here!  I would never have thought that you could totally erase a 40% outperformance through taxes.

Wow!  40% outperformance and a lower overall net return at the end.

I'd bet most "traders" use taxable money, so this is an extremely relevant article.  They probably also think they regularly get 100% returns and rare losses though, due to confirmation bias.

Very interesting article, thanks for sharing!

[Scandium]

wow, yes very interesting.
And he didn't consider trading costs either. Just as an example; two trades per week x $8 each for 24 years is another $20K lost.

[hodedofome]

wow, yes very interesting.
And he didn't consider trading costs either. Just as an example; two trades per week x $8 each for 24 years is another $20K lost.

I pay about $1-2 per trade and I try to trade no more than 5-10 times per year. A good trader lowers his costs as much as possible.

[Scandium]

wow, yes very interesting.
And he didn't consider trading costs either. Just as an example; two trades per week x $8 each for 24 years is another $20K lost.

I pay about $1-2 per trade and I try to trade no more than 5-10 times per year. A good trader lowers his costs as much as possible.

Specifically said weekly trader, so I assumed a buy & sell per week. And trading costs in 1990 was probably way more than $8 so it might be low if anything. I don't trade much myself, but most of the major places I've seen $5-9. Might be less if you do a lot obviously.

[blackomen]

This guy's the best trader ever, assuming his claims are valid.  I think he's even gone as far as to allow the IRS to release his trading records to anyone who requests them:

http://en.wikipedia.org/wiki/Dan_Zanger

Michelle Williams (yes, the actress) turned $10K into $100K and won the Futures Trading competition in the 90s.

Both Dan Michelle can pay capital gains and leave the wealth they've attained in money market funds for decades and still come ahead of buying and holding the S&P 500.

[sirdoug007]

Great.  So there are two people beat the S&P500 after taxes and trading expenses.  That doesn't mean that you or I can have any luck doing the same.

The key point of the article is that the delta between short term capital gains tax and long term capital gains tax will take a SIGNIFICANT bite out of any gains you manage in a trading (inherently short term) strategy.

For example, you set up two accounts with $10,000.  One in the S&P500 and one that you trade.  He ignores trading costs and assumes they are $0.  For someone with a marginal income tax rate of 25%, long term gains are taxed at 15%. 

At the end of the year the S&P500 account is up $1,000.  You pay 15% on the $1000 gain for a net gain of $850.
At the end of that year the trading account would need to be up by $1,133 to take the 25% tax hit and end up with the same $850 net gain.

But people just look at the $1,133 vs. $1000 and think, woohoo, I beat the S&P500!  I'm so smart!  In fact, you just broke even because uncle sam takes more from short term gains.  This preferential taxation makes it much harder to beat the market with trading.

So not only do you need to MATCH the S&P500.  You need to beat it significantly just to keep up.  It gets even worse as your income goes up because the delta between short and long term gains rates goes up to 20% at the 35% marginal income tax bracket.

[NorCal]

The key is knowing your marginal tax rate and your effective tax rate.  If you have a 40% marginal tax rate, the difference between short term and long term gains is huge.

If your marginal tax rate is 20%, the difference isn't as bad.  However, you still lose out on being able to reinvest taxed dollars.

It's always smart to execute any trading strategy (assuming that it's smart to make a trade) in a tax deferred account if possible.

[hodedofome]

FWIW you can trade stock index futures like S&P, NASDAQ and Russell 2k and pay 60 percent long term gains and 40 percent short term gains, no matter when you bought and sold.

[hodedofome]

Read this today and thought I'd post it:

http://www.mercenarytrader.com/2014/07/no-actually-the-worlds-greatest-trader-would-crush-the-sp-to-powder/

[sirdoug007]

That's quite the rant.  Obviously there are guys out there that beat the S&P500 over some periods of time.  You have to admit though, beating the S&P for 24 straight years would be quite the feat.

The point Ritholtz is making is that short term capital gains taxes are a significant drag on gains that most people love to ignore.  No doubt about that.

[waltworks]

IMO, beating the index year in and year out by 4% for 20+ years would make you a VERY unusual and awesome stock picker. I guess you could quibble with the "best ever" bit but IMO it's something even a very talented and dedicated person would find almost impossible.

Sure, you can find plenty of examples of folks who did WAY better over short periods of time, but you *expect* that result just based on chance. A market comprised entirely of millions of chimps would have a bunch of *amazing* traders who annihilated the S&P. But they probably wouldn't be as good at selling newsletters.

-W

Read this today and thought I'd post it:

http://www.mercenarytrader.com/2014/07/no-actually-the-worlds-greatest-trader-would-crush-the-sp-to-powder/