I recently had a conversation with a couple of investors who were currently dealing with big-bank brokerages. Coming from that background myself, I wasn’t surprised when these investors noted that their Advisors criticized the active trading approach to investing. Their logic behind the buy and hold “strategy” was that:
- You can’t time the market
- You want to avoid the tax consequences of realizing gains on an ongoing basis by holding rather than trading stocks
- Good stocks rise over time. If you hold on long enough, these stocks recover from losses
Argument #1: You can’t time the market
I probably don’t need to harp on the first point to readers of this blog. Those of us who understand what true “market timing” means, understand the concept of buying and selling based on specific trend analysis tools. More on this topic here.
Argument #2: Trading causes a tax burden
Let’s say you could find a group of stocks that you could be pretty sure will go up forever (this is a pretty bold statement to make—more on this below!!!). Great. So let’s say they go up at the same pace as a trading orientated portfolio does–lets suggest 10% per annum to pick a number.
This miracle stock collection goes up 10%/yr. for 10 years. To keep things simple–given no compounding of returns–your $1MM turns into $2MM.
You now have a $1MM gain. At some point, you will want to take money out – or you may choose to leave it in your will – in which case your estate will be faced with a gain. That’s going to be quite a tax bill.
The tax burden on the large gain ($1MM gain after 10 years) will be at a higher rate than had you realized each years smaller gain through an active approach. For example – lets say you make the the same $1MM over 10 years, but each year you realize $100k by selling some stocks. At 50% inclusive (current tax policy in Canada taxes only half of your realized capital gains on individual portfolios) this works out to be $50k/year taxable income. If your taxable income isn’t too high, you will likely remain in a lower tax bracket than had you realized the much larger lump sum $1MM gain at the end of the 10 years.
It doesn’t matter how much you take out after your portfolio has captured such a large capital gain–you now have $1MM in gain to pay tax on at some point- or your estate will. That which you don’t pull out will keep growing and increasing your future tax burden (assuming the stocks go up forever).
Again though–the chances of finding stocks that always go up without 5, 10, 15 or more years of underperformance is thin, as discussed next.
Argument #3: They’ll come back!
Most investments need to be sold at some point. If they don’t get sold at the right time, you lose money and/ or spend many years waiting to recover. Buy and hold does not work as people think. For example, here are some high quality stocks that many investors might think are ideal buy & hold stocks:
General Electric Company is still down from its 1999 high (16 years!)-that must be frustrating!
Microsoft was below its 1999 high until last year–it was a 16 year wait for those investors to break even! A long time to just make a 3% dividend.
Coca cola peaked in 1998–and spent 15 years (until 2013) falling and then trying to recover. A 3% dividend is all you made for that long lifetime of waiting!
Canadian blue chips like Manulife–still below its 2008 highs (8 years under water).
BCE stayed flat from 2000 to 2011–that was 11 years of waiting before it became profitable – beyond the dividend.
Former stalwarts like Bombardier peaked 16 years ago and is still falling. Nortel, Stelco and Teck were blue chip buy and hold stocks at one time. Need I mention Lehman Brothers, etc.?
Why lose money or make nothing just to avoid some tax? Pay the tax and take a profit–or watch the stock fall – lose capital or make little or nothing for years.
Instead of waiting, you could have taken the high profit on any of the above stocks after they rose in price, and moved it into another stock with better forward potential after they began rounding over. This allows you to earn greater and more immediate returns – rather than waiting for 5, 10, 20 years just to recover.
The information contained in this report is for illustration purposes only and was obtained from sources that we believe to be reliable however, we cannot represent that is accurate or complete. The portfolio may invest in leveraged or inverse exchange traded funds and thus there may be exposure to aggressive techniques which may magnify gains and losses and can result in greater volatility and be subject to aggressive investment risk and price volatility risk. All performance data represents past performance and is not necessarily indicative of future performance. Worldsource Securities liability shall only be attached to the accuracy of information contained in your official statement of account and information in your official statement of account will always take precedence over the information contained in this illustration. The figures are based on the portfolio holdings of Portfolio Manager Keith Richard’s account in the equity portfolio since June 30, 2009 and is gross of any fees and assumes re-investment of all distributions with no cash outflows or inflows. Values in percentage are annualized for periods of more than 12 months.