The Daily Dow
Tuesday, August 26, 1997
by Robert Sheard
LEXINGTON, KY. (Aug. 26, 1997) -- More on the 18-month holding period question today. This weekend, John Downes, co-author with Michael O'Higgins of Beating the Dow, was interviewed about the ramifications of the new tax laws on the now-famous strategy.
Downes, though, isn't as sanguine about the longer holding period as other researchers have been. In the interview, Downes claims that the 12-month holding period fares better than an 18-month holding period. Unfortunately, the interview doesn't include any data to demonstrate that claim. Our own TMF Sandy is currently running the numbers for his own 18-month historical test, but until he's finished (and it's very time-consuming), all we have is the secondary research we've read about elsewhere.
On August 4, I summarized a research study by Lawrence Pratt that points to 18 or 19 months as the optimal holding period for the ten high-yield Dow stocks. Pratt's study was carried out using 20 years' worth of data and tested holding periods from 1 to 36 months.
It's interesting, then, that Downes claims a different result for the two holding periods. Who's right? I suspect that it will depend, perhaps, on the length of the study and the period being covered. We'll know more when Sandy finishes his study from 1961 onward.
A couple of points to consider:
If the two holding periods yield closely similar returns, the roughly 30% one will save under the new tax laws makes the 18-month holding period attractive.
On the other hand, as Downes points out, about 60% of all the Beating the Dow stocks remain in the portfolio for a second year anyway, which would qualify the majority of the gains for the lower rate. The rest would be taxed as they have been previously, at the maximum rate of 28%.
Lest anyone panic too much over this issue, let me say that I think the holding period's effect on overall returns is unlikely to be wildly significant in either case. If Pratt's research is verified by TMF Sandy's much longer test run, we have the best of both worlds -- better returns and lower taxes. If Downes's claim of better returns with the 12-month holding period is borne out, then at the very worst, we're right where we were before (a 28% tax rate) on some stocks and we get a tax break on about half of the holdings (those that stay in the portfolio a second year).
If the rates of return are very close, the tax break for extending the holding period should give the 18-month holding period the advantage. As for the Dow holdings in the Fool Portfolio, the Gardners have decided to hold their stocks an extra six months to meet the new holding period requirement for the 20% rate. As always, as soon as anything objective is added to the picture, either from our own research or from other sources called to my attention, I'll pass them along to you here. Fool on!
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Stock Change Last -------------------- T - 1/4 40.00 GM -1 1/4 65.00 CHV - 5/16 78.25 MMM - 15/16 91.75
Day Month Year
FOOL-4 -0.91% 3.46% 9.57%
DJIA -0.98% -5.36% 20.69%
S&P 500 -0.77% -4.33% 23.26%
NASDAQ -0.64% -0.16% 23.26%
Rec'd # Security In At Now Change
1/2/97 153 Chevron 65.00 78.25 20.38%
1/2/97 179 Gen. Motor 55.75 65.00 16.59%
1/2/97 120 3M 83.00 91.75 10.54%
1/2/97 479 AT&T 41.75 40.00 -4.19%
Rec'd # Security In At Value Change
1/2/97 153 Chevron 9945.00 11972.25 $2027.25
1/2/97 179 Gen. Motor 9979.25 11635.00 $1655.75
1/2/97 120 3M 9960.00 11010.00 $1050.00
1/2/97 479 AT&T 19998.25 19160.00 -$838.25
CASH $1009.44
TOTAL $54786.69