Sauls KB Question

Investment Analysis Clubs Saul’s Investing Discussions
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“I always buy with the idea of holding indefinitely, never with the idea of a short holding period, but in practice I guess my average holding period is six months to three years.”
-Saul KB

Reading through Sauls KB, which has been hugely helpful as I try to wisely invest my new “disposable income” (I’ve never really had the option of investing b4), I had a a question about the generally philosophy of constantly re-assessing and re-allocating funds to companies geared for growth. This sounds like an obvious winning strategy but MF and other investing resources seem to suggest that the tax penalty of making multiple trades (and specifically selling) negates to a large degree any increased gains over the long term.

Any thought on this and more specifically do we calculate the tax penalty of more frequent transaction into our decisions? It seems like the answer is no, not even for short term capital gains. And are people including/incorporating tax penalties into the portfolio returns they list on here?

Thanks for your help, I’m learning a lot.

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P.S he did mention that a large chunk of his portfolio was in an IRA so that may allow him to do it tax free

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There is a section in the KB, about the middle of Part 2, which deals with this:

Do I wait for long-term capital gains? My results are for my entire portfolio, which includes various accounts, some taxable, some not.

Most positions I’d exit short-term would be losses or small gains. If a stock was really doing well I’d be more likely to add to it. If, for some reason, like a major change in the fortunes of a company, I had to get out of a position with a significant gain, I would do it in all my accounts, taxable or not.

Normally, to get to be a big gain it would mean I’ve held it for a year at least. It would be rare that I would be selling out of a stock with a significant short-term gain. So let’s say I do sell $120 worth of stock on which I have a $20 short-term profit. The key is that the tax is not on the whole $120, it’s just on the $20 profit. The difference in the short-term tax on that $20 profit and the long-term tax might be about $4.00. Should I risk the entire $120, keeping it in a stock I’m worried about, because I’m worried about $4 in taxes? When the stock could easily drop more than that $4 in a few days? When I could redeploy the money in something I prefer? I don’t think so.

Incidentally, earlier today I was doing some calculations just to get a feel for the drag that taxes create due to turnover. As an example, if you had an investment growing at 10% annually and did not liquidate until the end of 20 years, you’d end up with about 5.5x what you started with (assuming 20% tax on the gains). If you liquidated at the end of each year and bought something new, to reach the same final performance would require annual gains of about 11.5%.

The difference grows at higher growth rates, but the upshot is the same: a few percentage points of extra alpha are required to make the turnover worth it. I think it’s fair to say the goals of this board are to find returns that make that tax drag disappear into the noise.

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We should not scoff at a 1.5% difference in return over a long time.
Over trading is a well known reason for underperformance and taxes would be one of the reasons why.

10K invested for 30 years at 10% return, with no further contribution turns into $174,464
10K invested for 30 years at 11.5% return, with no further contribution turns into $261,966.

Compounding interest is one of most powerful forces in the universe.

There are times like UPST earlier this year, where stocks on the board have great run ups inside the 12 month period. I have shares of CRWD purchased in March 2020 at 37.75$, and if these had been sold prior to a few months ago, would have incurred LT taxes on the majority (80% or so?) of the sale. In these situations, you will need to be significantly right on both your sell and next buy to catch up.

I do think this is worth looking at when considering trimming and buying, sometimes the gains and timing may make holding make more sense if your conviction is not high and we are just “tinkering” with positions.

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We should not scoff at a 1.5% difference in return over a long time.
Over trading is a well known reason for underperformance and taxes would be one of the reasons why.

While it is true that “tinkering” is a form of over-trading that can generate costs of a number of types, I don’t think that is the point here. The point is to not over-think things or paralyze outsides when a critical decision should be easy to make; we want to avoid making a bad decision, or NOT making a good one, because of some detail or guideline that really, long-term, is impossible to measure in any meaningful way anyway. Before people start pulling out their abacuses to prove that you can indeed measure the difference (as the last post did), I want to point out I used the word “meaningful”. What I mean by that is simply that we make a lot of decisions for a lot of reasons and trying to look back and separate the components of each choice, in a non-biased way, to try and squeeze out an extra 1.5% return…well that way lies madness (at least for me).

Obsessive tinkering is one place we really can avoid some tax bills, but I hope none of us really believes we are just tinkering about without any other driving factor! Even learning can lead to improved returns, which tinkering probably can be attributed to anyway, if nothing else.

In my more recent experience it has been far more freeing (less stressful and easier to make a safe choice) if I just do it and not worry about making sure Quicken is up-to-date so I can see my current tax situation before selling a few shares of something for a good reason. The reason is far more likely to make or break a few % than a tax choice, long term.

E.g. if I feel XYZ is worth 14% of my portfolio today, and tomorrow I learn something that makes me feel 6% is a better allocation, I’m not going to worry about the taxes and stay in a situation that I believe is risky for that reason alone.

P.S. If I really believed I was aiming for a 10% return I would sell everything, buy some index funds and spend my time doing something else.
10K invested for 30 years at 20% return, with no further contribution turns into $2,373,763.
10K invested for 30 years at 25% return, with no further contribution turns into $8,077,936.
10K invested for 30 years at 30% return, with no further contribution turns into $26,199,956.
…I can make up more big numbers that are fun to look at…
…Knowing what the return would be if I allowed taxes to rule my decisions versus not…impossible. I would need to track a parallel reality with perfect clarity.
…I would also need to live another 30 years AND never use any of my money, which doesn’t sound very fun either.

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10K invested for 30 years at 20% return, with no further contribution turns into $2,373,763.
10K invested for 30 years at 25% return, with no further contribution turns into $8,077,936.
10K invested for 30 years at 30% return, with no further contribution turns into $26,199,956.

Your numbers are way off!

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The magic of compounding with a high rate of return for a long period - the numbers are correct!
Here are the year end balances of a $10k investment earning 30% for 30 years:

Period Accum Bal
1 ) 13,000
2 ) 16,900
3 ) 21,970
4 ) 28,561
5 ) 37,129
6 ) 48,268
7 ) 62,749
8 ) 81,573
9 ) 106,045
10 ) 137,858
11 ) 179,216
12 ) 232,981
13 ) 302,875
14 ) 393,738
15 ) 511,859
16 ) 665,417
17 ) 865,042
18 ) 1,124,554
19 ) 1,461,920
20 ) 1,900,496
21 ) 2,470,645
22 ) 3,211,839
23 ) 4,175,391
24 ) 5,428,008
25 ) 7,056,410
26 ) 9,173,333
27 ) 11,925,333
28 ) 15,502,933
29 ) 20,153,813
30 ) 26,199,956

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Channeling my inner-Saul…

“Magic of compounding” is not a topic for this board.

Let’s end this thread…NOW

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“Magic of compounding” is not a topic for this board. Let’s end this thread…NOW

You took the words right out of my mouth! I was just going to say LETS END THIS THREAD NOW!!!

Thanks for your cooperation,

Saul

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