Time to admit a mistake – but still slow investing …
Time to admit a mistake: Thanks to reader Roger, I found out that my table showing the tax benefit in the “discovery of slowness” post has some major errors. This was the table from the post:
| turnover/year | Total gain AT | p.a. AT | in% of max |
|---|---|---|---|
| 1 | 1024% | 8,4% | 35% |
| 2 | 1735% | 10,2% | 60% |
| 3 | 2061% | 10,8% | 71% |
| 4 | 2284% | 11,1% | 79% |
| 5 | 2363% | 11,3% | 82% |
| 6 | 2444% | 11,4% | 84% |
| 7 | 2529% | 11,5% | 87% |
| 8 | 2616% | 11,6% | 90% |
| never | 2896% | 12,0% | 100% |
Well, as always, what looks too good to be true isn’t true and now, you will not reap such large enefits by extending the holding period only a few years.
The mistake was that I actually did not calculate a full sale at each intervall but only a partial one. If I calculate the effect of a full sale, the table looks like this (with hopefully fewer mistakes):
| Avg. holding period | Total | P.a. | In % of total |
|---|---|---|---|
| 1 | 1024,3% | 8,4% | 35% |
| 2 | 1068,5% | 8,5% | 37% |
| 3 | 1112,8% | 8,7% | 38% |
| 4 | 1232,0% | 9,0% | 43% |
| 5 | 1201,2% | 8,9% | 41% |
| 6 | 1245,0% | 9,0% | 43% |
| 7 | 1361,3% | 9,4% | 47% |
| 8 | 1558,9% | 9,8% | 54% |
| never | 2896,0% | 12,0% |
It’s very easy to see that only the 1 year and 30 year number were correct, but in between the benefit of a longer holding period accrues much slower than in the initial version. The strange behaviour in the 4-6 year range is due to my arbitrary cut off at 30 years.
Holding your stock on average 8 years vs. 1 year still gives you 50% advantage after 30 years but it doesn’t look that spectacular. And to be honest: What fun it is to have for portfolio fixed for 30 years to gain the full “magic of compounding” before tax?
That led me to another thought: What is the impact if you manage to hold at least a certain percentage of your assets for along time ?
Again a very simple table to illustrate the effect and again hopefully with only a few mistakes:
| % 30 year vs. 1 year | Total | p.a. | In % of total |
|---|---|---|---|
| 0% | 1024,3% | 8,4% | 35% |
| 10% | 1211,5% | 9,0% | 42% |
| 20% | 1398,6% | 9,4% | 48% |
| 30% | 1585,8% | 9,9% | 55% |
| 40% | 1773,0% | 10,3% | 61% |
| 50% | 1960,1% | 10,6% | 68% |
This table shows under the initial assumptions (12% p.a., 30% tax on realized gains), how a portfolio develops consisting of one sub portfolio with 30 year holding period and the other with annual turnover.
The results are interesting if compared to the first table: Even if you manage to hold only 10% of your assets for a really long time, this is equal to increasing the total holding period of the portfolio to 4-6 years.
So a small percentage of very long holdings really can create quite a nice benefit after tax, even before transaction cost etc. Intuitively I was trying to achieve something like this by defining a “core value” sub portfolio but I didn’t focus that much on long holding periods yet.
So what now ?
This is what Roger commented:
If they are relevant for you and your investment strategy (as your article suggests) I would suggest to revisit your calculation.
At least for me it would be quite annoying to change my investment habits due to an important insight from a calculation and later having to recognise that calculation was obviously wrong.
Well the good news is: Holding stocks longer is still positive even with the corrected numbers. But more important was this part of the original post:
Secondly, and even more important, being slow in my opinion is the best defense against any kind of behavioural biases.
I think this holds true in any case and the tax effect is just a niece side effect. I hope that the major “behavioural” benefit from this rule will be better investment decisions and the ablitity to hold winners for a longer time. If I look into my personal portfolio, a disproportionate amount of “alpha” comes from my long term winners, not from my rather short term special situations kind of investments. And rather nothing on average from short term “spontanious” trades.
I don’t think that I have to sacrifice anything by limiting myself to one position change per month.
Even more, since I decided for myself to slow down which I did already a few months ago, oddly enough I feel more relaxed overall with regard to the markets and my cash position. I have to admit that I used to pressure myself to come up with many new ideas before actually drilling deeper into existing ones. Especially right now, with a lot of annual reports coming out, I used to feel some stress in the past. This year I am actually quite relaxed. As I already know what I do in April (buy a fund), I now have a lot of time and leisure to prepare a potential transaction in May.
value and opportunity 
It is right that accumulating capital gains (and paying taxes at the end of the investment career) has real benefits. But there is – in my view – still a mistake in your calculation. You are calculating the terminal value before tax. So in your 30-years-case the return is just compounding interest of 12% per annum. To be realistic you should deduct the 30% tax at the end as well. The residual value (for example to spent or to buy a home) would be 21,27 your investment – which equals a 2.027% gain (instead of 2.896%). This is still a 10,73% per annum net return which clearly outperforms the shorter holding periods.
We see this case the wonderful effects of compounding … which is for the benefit of both, the investor and the taxman. The tax you would pay in at the end of this 30-year-holding case would be 8,7 times your investment – or almost double the tax you would pay over time with the 1-year-holding periods.(You would pay later, which is by definition not beneficial for the taxman – but I doubt that the taxman would be able to invest these funds at a rate of 12%).
#helmut,
I deliberately did not calculate an exit tax. The reason is that in reality, if you save for retirement, you would not fully convert into cash but rather try to live of the dividends etc and only slowly convert into cash. So I do think not assuming an exit is actually the more realistic case.
mmi
Congratulation!
Many people have a problem admitting mistakes, especially that offensivecoram publico. But I suppose it is unavoidable to stay intellectually honest – toward others, but even more toward oneself.
mmi,
Some years ago I considered using active investment funds or managers. I concluded that I do not possess the talent to find the ones who will after fee deliver index beating results long term.
“What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. .. My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
BERKSHIRE H ATHAWAY INC. 2013 ANNUAL REPORT
Warren Buffett
“Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”
BERKSHIRE H ATHAWAY INC. 1996 ANNUAL REPORT
Warren Buffett
In other shareholder letters Buffet wrote also about this.
Regards
milud