The Daily Dow
Monday, September 29, 1997
by Robert Sheard
LEXINGTON, KY. (Sept. 29, 1997) -- After two weeks on sabbatical to work on my book manuscript, diving back into the daily stock market habit is a bit of a jolt. It's amazing how easy it is to ignore the daily gyrations when you turn off the television, ignore the newspapers, and bury yourself in something else. And maybe that's a good lesson for all of us to learn.
Here it is, two weeks later, and not a whole lot has changed since I left. The Dow is still hovering around 8000. The Foolish Four model from January is still lagging slightly behind the major indices, yet doing a whole lot better than six months ago. It's nice to know that constant hovering over the pot isn't required to make a good stew. Mix in your best ingredients and let time meld them together into a fantastic dish.
While I was gone, a number of readers new to the area asked whether the Dow Dividend Approach is really all that good an idea since one would be required to pay taxes after every portfolio adjustment -- unless the account is a tax-deferred IRA or 401(k). And it's true, taxes are something you should consider... so let's compare the alternatives.
The Dow Dividend Approach has averaged approximately 22% a year (before taxes) since 1971. Since all of the gains are on holdings of at least twelve months, the maximum tax rate would be 28%. If the entire portfolio were to turn over each year (which, of course, isn't the case), the after-tax return would drop to 15.84%.
If, however, you were to put your money into an index fund as a way of deferring taxes and letting your entire investment compound for many years, the return you would have received over the last two and a half decades would have been just over 13% a year. So, let's compound a $25,000 portfolio at 14% a year for 30 years. At the end of the 30 years, the total value would be $1,273,754. But built into that total is still 30 years' worth of deferred taxes. At the new long-term rate of 18%, you're still going to owe Uncle Sam $225,776 in taxes. That brings your after-tax value down to $1,047,978. Still more than a million dollars. Not bad, right?
Let's compare that to the Dow Approach. Even after having to pay 28% taxes on the total gain each year, that same $25,000, compounding for 30 years at the after-tax return of 15.84% would grow to $2,059,190, almost 100% more than the portfolio in an index fund that deferred the taxes for three decades.
Even though the Dow investor is going to pay nearly $800,000 in taxes over the 30 years, compared to only $226,000 for the index fund investor, the after-tax final net worth is still going to be twice as large. So yes, the issue of taxes is always important to consider, but make sure you use the after-tax rate of return as the real comparison.
With the new lower capital gains rate for holdings of 18 months or longer, this gap between tax-deferred index funds and taxable Dow portfolios will grow even larger. If the test our research staff is running verifies the study by Lawrence Pratt, which suggests that the optimal holding period for the high-yield Dow stocks is 18 months anyway, we could be looking at an even better performance for the Dow Approaches and lower tax rates.
Or better yet, throw $2,000 a year into a Roth IRA if you're eligible and escape taxes altogether for the next 30 years! Fool on!
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________
Stock Change Last -------------------- T - 1/4 45.19 GM + 13/16 66.81 CHV +1 7/16 84.50 MMM +1 7/8 92.31
Day Month Year
Day Month Year
FOOL-4 +1.08% 10.99% 17.56%
DJIA +0.87% 4.84% 23.93%
S&P 500 +0.86% 5.99% 28.70%
NASDAQ +0.76% 6.79% 31.29%
Rec'd # Security In At Now Change
1/2/97 153 Chevron 65.00 84.50 30.00%
1/2/97 179 Gen. Motor 55.75 66.81 19.84%
1/2/97 120 3M 83.00 92.31 11.22%
1/2/97 479 AT&T 41.75 45.19 8.23%
Rec'd # Security In At Value Change
1/2/97 153 Chevron 9945.00 12928.50 $2983.50
1/2/97 179 Gen. Motor 9979.25 11959.44 $1980.19
1/2/97 479 AT&T 19998.25 21644.81 $1646.56
1/2/97 120 3M 9960.00 11077.50 $1117.50
CASH $1167.51
TOTAL $58777.76