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My Sunday Washington Post business section column is out. This morning, we look at the impact of taxes on personal trading accounts. The print version used the headline A harsh reality for all you stellar
active traders; the online version is So you’re the world’s greatest trader? Taxes will fix that.

The bottom line is that even a 40% gain over broad indices is insufficient to beat the taxman’s short term 30% bite.

Here’s an excerpt from the column:

“Imagine that 24 years ago, your best friend invested $10,000 in the S&P 500 and held on through last year. He would have amassed $76,266. That number includes taxes paid annually on whatever dividends came his way at the highest taxable bracket.

Compare that with you, the World’s Greatest Trader. Had you put that $10,000 into a trading account that same year and annually crushed the S&P 500 by 400 basis points, you would have amassed an after-tax return of only $69,197.

In other words, your passive-index buddy would have beaten you, the World’s Greatest Trader, by about 10 percent. (Note that I am ignoring all of your trading costs.)”>

The post included the spreadsheet we used to test this.  A screen grab is below, or you can download this and play with it yourself.

trader tax.xls
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click for ginormous version of print edition
spread

 

 

Source:
So you’re the world’s greatest trader? Taxes will fix that
Barry Ritholtz
Washington Post, July 27 2014 
http://wapo.st/1xjB4kW

Category: Investing, Taxes and Policy

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “What if You Were the World’s Greatest Trader® ?”

  1. daveslade says:

    The buy and hold results have an embedded tax liability that should be adjusted to compare the results in terms of what the money really means to the investor or trader.

    ~~~

    ADMIN: Thats true, but the vagaries of trading point is made. And if the out-performance was 130% of SPX instead of 140%, the trade would net net still lag after the long term investor paid the embedded tax.

    But point taken.

  2. jck says:

    I believe there’s a minor error in G17. Should be .30 tax rate, not .70. All the loss years have .70 although the formula forces to 0.00 … but G17 wasn’t a loss year. I’m playing around with the spreadsheet because I want to adjust the assumed 30% tax rate. Saw Michael’s original post, was intrigued and was hoping he would “show his work” because the claim seems dubious. So I’m happy to see this followup. Thanks!

  3. sjperper says:

    with regard to world’s greatest trader…
    1 Is the statement about the tax carry forward limitation of 3k correct? There is a 3k limitation on income offset per year, but I thought tax carry forwarding and gain offset are unlimited!?!
    2 The column labels on the published table and spreadsheet are different.
    3 It is not clear that the “great trader” is getting credit for any dividends…. is that correct?
    4 I would have thought I could calculate the passive investor percentage growth by adding the S&P return to the dividends after tax, but that is not working for me. The spreadsheet does give any insight into how these numbers were calculated

  4. machinehead says:

    ‘Crushing the S&P by 400 basis points’ means the formula in cell J2 should be K2+0.04, not multiplying by 1.4 (which produces far more than 400 basis points in big up years).

    Column G (tax on gain) contains several inconsistent formulas. If the trader is given the benefit of ordinary loss carryforwards ($3,000 per year) to shelter other income, his terminal wealth exceeds that of the buy and holder.

  5. CD4P says:

    Well, BR: while following the link to read your latest virtuous piece, I spotted this equally significant (given people’s homes are often their largest asset value) item: http://www.washingtonpost.com/business/economy/after-foreclosure-an-effort-to-repurchase-a-home/2014/07/25/1296966e-1142-11e4-8936-26932bcfd6ed_story.html?tid=recommended_strip_3

  6. b_thunder says:

    I’d like to take an issue (or three) with this analysis:

    1. I learned to distrust selective data series/charts/tables from non other than Barry Ritholtz. Recently he has been relentless in pointing out when other pundits/bloggers/money managers use data mining and present selective data to support their hypothesis. Just recently he was slamming the charts comparing Dow in 1929 and 2013, S&P500 in 1987 and 2013, and various gold price charts, among others. So it’s surprising to see him use 1990-2013 time period to further his and his firm’s case for passive investments. Why 1990 and not 1980 or 2000? Why 2013 and not 2008? Neither 1990 nor 2013 are peaks or troughs of the cycle (which I think would be more fair and “natural” dates to pick to judge the performance.)

    2. Who exactly decided that the “greatest traders” are those that beat “the market” every year by a certain percentage? What methodology did the “deciders” use and why?
    IMHO, the greatest traders are those who capture multi-year upsides (while not necessarily outperforming “the market”) AND avoid 50% drops. The last part is especially important, IMHO.

    3. In the article Barry writes that “Sizable portfolios in the 2008-2009 crash lost millions of dollars. Folks who sold at the bottom in 2009 lost anywhere from 40 to 60 percent.” With all due respect, I’d never call the folks that sold at the market bottom great or even good traders, and since the rest of the article compares “great investors” to the passive investors, why did Barry add the typical wall st prey (chumps that buys at the top and sells at the bottom) into the mix?

  7. WKWV says:

    It arguably unreasonable to have the buy-and-hold investor never sell, and so never pay any capital gains, while the super-trader does so every year. Indeed, when the (soon-to-retire) buy-and-hold investor finally does sell his/her investment at the end of 2013, he/she must pay about 20% taxes (15% federal + 5% state & local) on the long term gain, or 0.20* ( $76,266.75-$10,000) = $13,253.35. The tax on this final sale reduces his/her gross total of $76,266.75 to the net total of $63,013.40. This is about $6,184.46, or 8.94%, less that the super-trader. So the super-trader does come out ahead – for all that effort – albeit remarkably less that many of us might have anticipated.

    Of course, our buy-and-hold investor might never sell, and so leave his/her heirs to benefit from the much increased basis of $76k vs. $10k. P.S. I come close, but am unable to exactly reproduce column J from B, M and N.
    Spouse of WKWV

  8. macritchie says:

    Don’t really know where to start on this one, but lets begin with the assumption that the worlds greatest trader only beats the market by 400 basis points, this isn’t just wrong it’s absurd. I could name a litany of traders from multiple independent sources that utterly destroy that figure. Pick up any one of Jack Scwagers MW books and you’ll find traders beating the averages by 1000 basis points and in some cases much more. In addition is the fallacy that great trading is defined by top line performance against a benchmark and as a professional trader I’ve just never met a really great or heard a ‘worlds best trader’ who thinks like that. This also says nothing to the worlds best traders returns relative to volatility as even decent traders whip the pants off of the overall market return relative to volatility.

    This has the feeling of ‘if you can’t beat em, join em’ so the buy and hold index gang doesn’t have to feel bad or apologize for their lackluster performance. I’m actually thankful people believe these kind of misguided notions, stuff similar to the EFM hypothesis as in the worlds of a world class trader I know real well ‘you keep believing that, and I’ll keep on trading.’

    Cheers

  9. carryforward says:

    Barry has made a serious error here, as noted by sjperper.
    Your losses can only offset a maximum of $3,000 of income in the year they are incurred.
    But they can be rolled forward and used to offset any amount of gains in the next year.
    If you lose $500,000 in 2008, you can claim $3,000 against your taxes and carry forward $497,000 in losses. If you then make $100,000 in gains in 2009 you can offset all of them (i.e pay no tax on them) and carry forward $397,000. And so on.
    I assume Barry’s finances are too complicated for him to file his own taxes, so I’m tempted to give him a pass on this one!