What do fund managers tell us to do? 
Buy and hold, ride out the bumps, stay invested for the long term.
But behind the façade, do they practice what they preach?
NO - they buy-sell-buy-sell-buy-sell in a frantic and desperate bid to top the performance tables for the next quarter.
That’s why they under-perform the average stock market growth.
Three problems with high-frequency trading
1) Transaction costs - these tend to be lower in shares (brokerage costs, stamp duty – though no stamp in Oz thankfully) than they do in property (stamp duty, legal fees, agent’s fees), but they are still there and they do have an impact
2) Poor timing – most people are rubbish at timing the top and bottom of the market
3) Capital gains tax
Effect of tax
Here’s a hypothetical investment that doubles in value each year and then tax is paid at a notional 30% on the profits before reinvestment:
|
Starting capital |
Capital doubled to:
|
Tax at 30%
|
Finishing capital
|
|
$10,000
|
$20,000
|
$(3,000)
|
$17,000
|
|
$17,000
|
$34,000
|
$(5,100)
|
$28,900
|
|
$28,900
|
$57,800
|
$(8,670)
|
$49,130
|
|
$49,130
|
$98,260
|
$(14,739)
|
$83,521
|
|
$83,521
|
$167,042
|
$(25,056)
|
$141,986
|
Here’s another hypothetical investment where the investor holds for the full 5 years then sells, incurring capital gains tax at the reduced rate of 15% (see note below):
|
Starting capital
|
Capital doubled to:
|
Tax at 15%
|
Finishing capital
|
|
$10,000
|
$20,000
|
$-
|
$20,000
|
|
$20,000
|
$40,000
|
$-
|
$40,000
|
|
$40,000
|
$80,000
|
$-
|
$80,000
|
|
$80,000
|
$160,000
|
$-
|
$160,000
|
|
$160,000
|
$320,000
|
$(43,500)
|
$276,500
|
In Australia there is a 50% exemption where an asset is held for more than 12 months.
Complicated, but the principal here is the important thing!
Table 2 shows that while the tax is Year 5 is rather eye-popping, the net result is far better.
Do the rich pay much tax?
Well, we know that companies sure don’t - but what about individuals?
We know that Kerry Packer wasn’t a fan of tax telling the Senate that people who didn’t minimise their tax “need their heads read” because governments tend to waste a lot of taxpayer money.
George Soros took a different approach, incorporating his famous Quantum Fund in a tax haven (Netherlands Antilles).
Warren Buffett minimises his tax in two ways.
Firstly his company Berkshire Hathaway has only ever paid one dividend (dividends from company profits are effectively taxed twice, once in the company and once in the hands of the recipient).
He mused: “I must have been in the bathroom at the time.”
The second way he reduces the impact of tax is by not selling.
Buffett’s preferred timescale for holding a quality investment is forever
What does it mean for us?
The buy and hold strategy offers the average investor the best chance they have of not being average.
The strategy that is most often effective is:
- Identify a quality asset (shares in a great company or property in a great location)
- Buy it at the right price (also known as investing counter-cyclically or “don’t follow the crowd”
- Hold it for the long term
It’s a long way removed from the Gordon Gekko image of the mad-crazy-impulsive Wall Street trader.
But guess what?
It also works.
