Posts filed under “Apprenticed Investor”

What if You Were the World’s Greatest Trader® ?

So you’re the world’s greatest trader®? Taxes will fix that.
Barry Ritholtz
Washington Post, July 27 2014



Imagine the following: You, the investor, believe you have an uncanny skill at picking stocks. You set up an online trading account and begin to buy and sell.

As it turns out, you are quite good. You pour more money into your brokerage account and up your trading. After the first year, you look at your results: You have trounced the indexes. You snicker at your friends who invest passively in low-cost, low-turnover indexes.

You keep at it, year after year trouncing the Standard & Poor’s 500-stock index. Over the long haul, you beat that benchmark substantially — in some years, you gain 30, 40, even 50 percent more than the SPX gains. You track your returns in a spreadsheet to see just how well you have done.

Over 24 years, you tally up gains and losses. The markets are up, on average, about 9.3 percent annually. You, the World’s Greatest Trader®, do much better — 40 percent better. That’s better than most of today’s hedge funds. It is certainly better than most average mom-and-pop investors.

How did you do vs. your friends the passive indexers?

About the same.

Wait, how on Earth is that possible? You trounced the indexes, you crushed the benchmarks, you are the greatest! How could this possibly happen?

In a word, taxes. Traders pay a healthy tax of 30 percent or more on short-term capital gains. (See spreadsheet at right). Effectively, you lose the benefits of compounding on one-third of those gains. Over time, this has a tremendous impact on your net returns.

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.)

Now imagine the same sort of trading account; only this time, add in a retail stockbroker’s commission. The outcome is utterly absurd. (How are any of these folks still in business?)

The number-crunching for this analysis comes from Michael Batnick, whose blog is (humbly) called the Irrelevant Investor. He is also, not coincidentally, my firm’s director of research. When he first ran the numbers, he spent a few hours scratching his head in astonishment. We tried hard to pick holes in it. Sure, it’s well established that passive beats active most of the time before taxes. Once we added in the big slice of the pie to Uncle Sam, active trading began to look downright silly. Makes you wonder why anyone would engage in such a ridiculous hobby!

How can the big boys do this? Mutual firms and hedge funds have a huge advantage that you, the individual investor, do not. They are a business. As such, they pay taxes on their total net gains. Losing trades offset winning trades dollar for dollar. Their investors also pay taxes on their net returns (not on each winning trade). This is why they can get away with this sort of active trading. Their tax bite is much, much smaller.

As an individual investor, you get to carry forward a grand total of $3,000 a year in losses to offset those gains. 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. They’d better watch their blood pressure and cholesterol if they want to carry those financial crisis losses forward for the next 150 years or so.

Long-term investors who use an asset-allocation model have another advantage over active traders: tax-loss harvesting. It’s a product of the latest software innovations.

Even when it was being done previously (which it often wasn’t), it was an inefficient act of guesswork, as well as a commission-generating sales tool. Today, it’s a precise process to efficiently capture tax losses at the touch of a button.

How it works: Any asset-allocation portfolio will see various asset classes gain and lose relative to their model weighting (e.g., 60/40 stocks and bonds). It’s a good idea to rebalance quarterly. Rebalancing back to your original weightings has been shown to add 75 to 150 basis points of additional returns over the long term, at no additional cost or risk. It is the closest thing to a free lunch that Wall Street has to offer.

Thanks to new software, investors can harvest some of their tax losses to offset capital gains during the rebalancing process. I like the program iRebal, which was bought by TD Ameritrade in 2006. It is both powerful and flexible. But there are lots of others on the market, and if you use an online broker, you probably have access to one for little or no cost.

What about the World’s Greatest Trader®? He has two choices: He can quit his job to open a hedge fund, or he can invest in an asset-allocation model using broad indexes or ETFs, rebalancing regularly.

The choice is his.

Next time: the World’s Greatest Market-Timer®.


Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Twitter: @Ritholtz.


Category: Apprenticed Investor, Investing, Taxes and Policy

Worst Investment Ideas of 2014 (so far)

    My Sunday Washington Post Business Section column is out. This morning, we look at the worst investing ideas of the year. The print version had the full headline Where dumb money goes; the online version is the worst investing ideas this year. Here’s an excerpt from the column: “Here is the first half of…Read More

Category: Apprenticed Investor, Really, really bad calls

How to build your own financial dream team

Curate your personal investment resources Barry Ritholtz Washington Post, June, 15, 2014   One question I get all the time from investors is “How do you sift through all of the news, data and media?” thrown at investors each day. I use some time-saving methods to quickly plow through a huge volume of material. If…Read More

Category: Apprenticed Investor, Investing

Curate Your Personal Investment Resources

> My Sunday Washington Post Business Section column is out. This morning, we look at how to build a personal online research team. The print version had the full headline How to build your own financial dream team, while the online version when with Curate your personal investment resources. The goal here is to take advantage…Read More

Category: Apprenticed Investor

Congratulations, You Were Drafted. Prepare To Go Broke.

Professional athletes need to learn to keep their finances in good shape Barry Ritholtz, Washington Post, May 30, 2014     Michael Sam made sports history when the St. Louis Rams made him the first openly gay player to be drafted into the National Football League. If he is smart, he can join another elite…Read More

Category: Apprenticed Investor, Investing, Sports

Congratulations, you were drafted! Prepare to go broke.

>   My Sunday Washington Post Business Section column is out. This morning, we look at how often pro athletes manage to go financially bust. The print version had the headline Congratulations, you were drafted! Prepare to go broke!, while the online version is merely Professional athletes need to learn to keep their finances in good…Read More

Category: Apprenticed Investor, Foreclosures, Investing, Really, really bad calls

Smart Investing is Reality-Based

Robert P. Seawright is the Chief Investment & Information Officer for Madison Avenue Securities, a boutique broker-dealer and investment advisory firm headquartered in San Diego, California. Bob is also a columnist for Research magazine, a Contributing Editor at Portfolioist as well as a contributor to the Financial Times, The Big Picture, The Wall Street Journal’s…Read More

Category: Apprenticed Investor, Investing

My Unusual Career Path in Finance

I have been working in finance for two decades. Along with achieving whatever success and (internet) fame comes regular inquiries from the young’uns seeking advice on how to break into the field. On occasion, I have shared whatever small insights I might have with them. Along those lines, Tom Brakke of the blog The Research…Read More

Category: Apprenticed Investor, Markets, Philosophy

What ‘This Time It’s Different’ Really Means

Investors must recognize what ‘this time it’s different’ really means Barry Ritholtz, Washington Post May 18, 2014     “The four most expensive words in investing are: ‘This time it’s different.’” So said Sir John Templeton, the legendary investor and mutual fund pioneer. The phrase contains tremendous wisdom, but only if you truly understand what…Read More

Category: Apprenticed Investor, Investing, Psychology

When is ‘this time’ really different?

    My Sunday Washington Post Business Section column is out. This morning, we look at a famous aphorism from Sir John Templeton. The print version has the hedder When is ‘this time’ really different? while the online version used the fuller Investors must recognize what ‘this time it’s different’ really means. The column tries…Read More

Category: Apprenticed Investor, Psychology, Quantitative