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This is a great post, and reinforces some conclusions I had been coming to
for my own activities. Tax management is a key issue in trader/investor
profitability. The two additional thoughts (for a US trader)that come up
are:
- consider restricting short term trading activities to tax-deferred
accounts, such as IRAs
- consider shifting trading activity to the futures markets. Futures gains
are treated under Section 1256 as 60% long term and 40% short term. And
record keeping is much easier as you don't have to keep track of basis
- compare trading and backtesting results on an after-tax basis. i.e. if you
have a trading strategy you want to compare to buy and hold, then consider
your results after applying short term capital gains taxes to the trading
strategy and lower long term capital gains rates to the buy and hold. Your
short-term return needs to be 30% higher or more (depending on the exact
rates you use) to be at after-tax breakeven.
Of course, most traders lose money in the first few years, so you can build
up a nice loss-carryforward to shelter your gains (if and when you start to
make them) for a few more years. So you have to have been profitable for a
while before you care - maybe that's why we don't hear much about tax
strategies for traders!
Best
Andrew
-----Original Message-----
From: equismetastock@xxxxxxxxxxxxxxx [mailto:equismetastock@xxxxxxxxxxxxxxx]
On Behalf Of superfragalist
Sent: Monday, June 27, 2005 12:55 AM
To: equismetastock@xxxxxxxxxxxxxxx
Subject: [EquisMetaStock Group] Re: William Bernstein
Andy,
Here are the results from Bernstein's buy and hold asset allocation methods
based on my implementation of them.
1998 -7.86
1999 27.73
2000 3.30
2001 2.83
2002 1.76
2003 49.95
2004 23.76
YTD 4.35
The statement I made was if I had used Bernstein's approach, I would have
been nearly as well off money wise as I have been trading.
Your question implies do I do better than the numbers above from trading.
Yes, considerably better. However, when you consider that the numbers I've
given you are nearly all capital gains, the issue becomes taxes and
expenses.
If you consider Federal and State Tax on my trading profits, I pay nearly
50% of my earnings to the government. Then there is the issue of
expenses--data, professional fees for accountants and attorneys, educational
materials, equipment and software.
There is no social security tax, nor can I deduct expenses because I don't
file as a trading business. I can't contribute to a defined benefits plan or
SEP or 401K. I could set up a Sub S and trade from that but it triggers
automatic detailed audits when it's a trading company, which I don't much
like based on the others I have had to put up with.
When I draw money out of a buy and hold account, I don't pay tax on the full
amount. I only pay tax on the difference between my cost basis and the gain.
On the gain I only pay 15%. So I don't need to draw out as much to have the
same after tax income. When you figure it all out, my taxes would be very
small on draws from the buy and hold accounts.
None of this includes time, hours and hours of time. What's that worth? Over
the last five years, I've put more hours into my trading than I did when I
was working full time. My previous job was very demanding, trading demands
more.
When I take all of the factors into consideration, for me, I can't give
trading an overwhelming endorsement even though I actually make money from
it.
Before I started trading full time, I worked the problem backwards. In other
words I estimated what I would make from buy and hold and then what I would
have to make from trading to beat that including the taxes, expenses, etc. I
missed the time estimate.
So far my financial models have been within the expected tolerances, but
each year when I evaluate the comparable worth including the intangibles,
it's a hard question to answer in hindsight between which method would have
been better.
One of the issues for someone who has to make a living from a buy and hold
asset allocation model is the performance of the model during the first
three years. The first three years generally determine how successful the
method will be over the long run.
For example, if I had started the Bernstein method with a combination of a
couple of losing years and then a strong year and then a couple of
profitable but low return years, the Bernstein method would not compare as
favorably to trading as it does. Not only is there drawdown from losing
money, there is additional drawdown from living expenses. That extra
drawdown makes it harder to recover in the good years. You can easily see
this with Monte Carlo simulation, which I have run on a number of asset
allocation models.
For anyone who is not trying to make a living off of a portfolio, then the
starting point is not nearly so important. In that case, I almost always
recommend the asset allocation model instead of trading.
For those who want to have some fun trading or swinging for home runs or
whatever, I suggest they put 90% of their assets into the model and only
trade with 10%.
As I mentioned in the other articles, there have been other benefits to
trading outside of the money. However, in reviewing the last five years,
it's a tough choice--at least for me.
Everybody has their reasons for whatever they do. I don't mind sharing my
reasoning if it helps someone else make an informed decision.
--- In equismetastock@xxxxxxxxxxxxxxx, "metastkuser" <andysmith_999@xxxx>
wrote:
> Super. If I recall correctly, you said in a prior post that had you
> used Bernstein's approach, your trading results over the last few
> years would be no worse than they are now? Surely that can't be right.
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