My Sunday Washington Post Business Section column is out. This morning, we revisit the advantages the long term passive indexer has versus short term active traders.

The print version had the full headline The trader can narrow the gap but won’t win, while online, it was called No matter what, the long-term investor comes out ahead of the short-term trader.

Many of you wrote in to point out some errors I made that disadvantaged the trader. In this week’s column, I took reader’s suggestions about taxes and dividends. I made the appropriate adjustments in the trader’s favor:

“Last time, we looked at why traders are at an almost insurmountable disadvantage against investors due to short-term capital gains taxes. Many of you wrote in to note several factors that would have allowed the active trader to narrow the gap against the long-term investor. A few of you asked how likely it was that a trader would outperform by that margin year after year. This week, I want to review those issues readers raised, looking to see how they affected our competition between the long-term indexer and the short-term trader.

Spoiler alert: The issues to which I gave short shrift did improve the performance of the trader, but not nearly enough to narrow the gap between the two. Let’s look at the details”

The takeaway is that short term trader’s have a remarkable bogey to over come: The much higher rate they pay for capital taxes.



No matter what, the long-term investor comes out ahead of the short-term trader
Barry Ritholtz
Washington Post, August 10 2014

Category: Apprenticed Investor, Investing, Trading

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.

7 Responses to “Another look: A short-term trader won’t beat long-term investor”

  1. Capitalist Canuck says:

    “The takeaway is that short term trader’s have a remarkable bogey to over come: The much higher rate they pay for capital taxes….the active trader “only” has to outperform the S&P 500 by 25 percent instead of 40 percent.”

    In Canada, this is a constantly miscalculated issue.

    We have a tax deferred account (RRSP) where gains are taxed upon withdrawal only, thus negating all trading taxes. The withdrawn dollar is taxed as income, not capital gain.

    We also have a completely tax free account system (TFSA) in which all forms of gain are non-taxed, even upon withdrawal. Again, negating all trading (and indexing) taxes.

    It would be in fully-taxed accounts only where the active trader faced the 25%-or-better barrier to beat indexers.

  2. sellstop says:

    So the take away is that it is possible to beat the averages as a trader. You can’t beat the tax man is the problem.
    Perhaps. It still depends on your rate of return vs. the averages. Most investors can’t match the averages. They are “the averages” after all. And the “average trader” is, well, average.

    Trading well is so much more personally satisfying though. You have to be a little crazy to do it well tho.

  3. dvdpenn says:

    What about short-term trading in an IRA?

  4. tigerlilac says:

    Barry, I know the capital to invest is limited but I trade in my SEP accounts which allows me to trade (turn) investments without short term capital gain treatment and at discount brokerage fees. I think that changes your analysis. It also makes me pay closer attention to the market and the perception of other investors that does not always equate to real asset value.

    Facebook and Apple have been very, very good to me; Facebook in particular has favored a trader. I certainly have made my fair share of poor investments (GFI at what I thought was rock bottom) as well. Ringing the register and admitting mistakes can be a good thing.

  5. boveri says:

    I agree that most short-term traders who trade the market swings without much concentration on macro factors affecting the market will likely not fare well.
    Those who apply themselves fully on a daily basis to study and calculate all fundamental factors for both the stock and bond markets can exceed the returns of a market indexer by being an informed and judicial market speculator who can escape the brunt of a bear market. Without an intervening bear market it would not be likely that an indexer could be beaten.

  6. Berkeley Maven says:

    The whole active/passive debate has always seemed quasi-religious to me.

    Most of the studies that show how passive funds beat the vast majority of active funds include all the high-expense, broker-sold crappy active funds. The picture changes significantly if you limit the universe of active funds to those relatively few that are low-cost, disciplined, good long-term record with same managers who eat their own cooking, etc.

    As an agnostic, I use passive approaches in taxable accounts, where it’s really hard to beat the tax man, and active approaches in retirement accounts, where you have a decent chance of adding 1% – 2% per year.

    That said, if you don’t want to bother or risk under-performance, there’s nothing wrong with going passive across all portfolios.

    By the way, I don’t consider all the *fundamental-indexing* and *smart-beta* vehicles to be passive. They are rules-based active bets. Some of them are doing pretty well, but it remains to be seen if the out-performance will persist.

  7. marketmap says:

    Yet, if you use a model / process that generates reliable outcomes with a low frequency of transactions, then the affect of taxes can be acceptable .