Imagine you’re John Templeton, George Soros, and Paul Tudor Jones all rolled up into the worlds greatest trader. Since 1990 you were able to beat the S&P 500 every year by forty percent. If the market was up 10%, you were up 14% and if the market fell 10%, you were down only 7.15%
Beating the S&P 500 in any given year is a challenge. Beating the S&P 500 every year for nearly a quarter century is extraordinary. Beating the S&P 500 every year for nearly a quarter century by forty percent is all but impossible.
Typically when people look at performance numbers for active trading strategies, they look at gross returns and don’t pay attention to taxes. I wanted to see just how damaging paying taxes on short term gains would be to a taxable portfolio.
Going back to 1990, had you invested $10,000 in the S&P 500 and held on through 2013, you would have amassed $76,266 (assuming taxes are paid annually on dividends).
If the best trader of all time invested $10,000 in 1990 and beat the S&P 500 every year by forty percent, net of taxes he would have amassed only $69,197, less than the buy and hold investor (not even factoring in trading costs).
These numbers are pretty astounding but I want to emphasize that the point of this exercise is not to suggest that trading is for fools, or that it can’t be done. I want to demonstrate that taxes on short term gains can be a huge impediment to accumulating wealth. Had the best trader of all time achieved these same returns in a tax deferred account, he would have amassed almost $192,000!
Nobody can argue that buy and hold is rife with drawdowns, does nothing to stroke your ego and is extremely boring, however, for taxable accounts, you’d be hard pressed to find a better alternative.