Investing For Growth
Investing For Growth
|
|
||
|
|
||
|
||
|
FOOL GLOBAL WIRE LEXINGTON, KY. (November 26) -- So what's the big deal with taxes, anyway? Every time we develop a new screen with a good intermediate- or long-term track record (a decade or two), skeptics come crawling out of the woodwork and want to destroy the approach with the wizard's wand of taxes. As if no other investments are taxed?
First of all, let's make clear the distinction between long-term and short-term gains. Until you make enough taxable income (well into the $90 thousands) that you climb into a tax bracket higher than 28%, there is no distinction at all between what you'll pay on short-term and long-term gains, so the issue isn't relevant for most investors. You're simply taxed using your ordinary income tax bracket, whether you hold the stock an hour or a decade. So except for the wealthiest of all Americans, the issue of higher taxes with my growth screens isn't even an issue.
But for those lucky few (among which, alas, I cannot count myself), let's look at the numbers. I want to put out three scenarios.
Johnny Index believes in the Efficient Markets Theory, meaning he doesn't think anyone can beat the market in the long run and sticks his money in an Index fund. A Foolish move, even if for all the wrong reasons. Assuming a 12% annual return for 30 years and taxes deferred until the end of the three decades, Johnny Index's $50,000 would grow to approximately $1.5 million. When he sells after 30 years, his 28% tax bite reduces that total by $405,000. At the end of 30 years, then, he's left with roughly $1.1 million (after taxes).
Tracy Dow is willing to invest 30 minutes a year for the extra returns offered by investing in the Dow Approach. Assuming a return of 22% for those 30 years, and paying 28% in taxes each year on the entire gain (which isn't realistic since only half the portfolio turns over each year, but it's close enough for our purposes), Tracy's portfolio after 30 years would be worth $4.1 million. Not bad ... an extra $3 million over 30 years for buying the stocks yourself once a year.
And finally, Susie Growth was willing to pay the full-boat current taxes of 39.6% each year on the short-term gains achieved by the Unemotional Growth screens. Assuming a 40% return before taxes and complete turnover each year, Susie's $50,000 portfolio 30 years later has grown to $33 million after taxes.
So before you let taxes worry you too much, do some of the math for your own situation and figure out the after-tax returns you would actually achieve over a long period. Buying and holding forever does not eliminate taxes; it simply defers them, and if by deferring taxes you're ultimately settling for a lower after-tax return, who's winning?
Go ahead and pay Uncle Sam and Aunt State whatever they're going to take and get better long-term returns by using more active portfolio management. Even buying and holding the best stocks around, you're going to be hard-pressed to beat the returns you can achieve with the Dow Approach or growth stock investing with a minimum of regular maintenance. Sure, you'll pay more in taxes, but after you've paid them, you'll have more in your pocket, too. It's a win-win situation. Taxes DO NOT derail these approaches. |
||
|
||
|
