Stock pickers manage their portfolios as if taxes do not
matter. The average active manager has approximately a 100% turnover
rate per year, while index funds range from 5% to 35%. The cost of
turnover is detrimental to the overall performance of the portfolio.
There is a substantial incentive for investors to hold their stocks for a year or more. For stock sales with holding periods of less than one year, the gain is treated as ordinary income and is subject to the full federal and state tax rate.
Depending on the tax bracket and state of residence, this could be 39.6% for federal taxes and 11% for state taxes and can have a dramatic impact on actual returns. For holding periods of one year or more, the tax rate is reduced to the long-term capital gains rate of 15%.
The dangers of stock
picking become crystal clear when we focus on the best, brightest, and
most famous stars of the investment industry. (More Bad Bets and Big Losses)
For many mutual fund managers,
analysts, traders, stockbrokers and various other individuals associated
with the financial industry, the idea of index funds strikes fear in their
hearts. This is because stock pickers and analysts charge very high fees
on mutual funds, and these fees pay for a lot of the jobs in the industry.
It is in the interest of these stock, time, manager, and style pickers
to imply that a market can be beat by listening to their strategist or
by risking money with their manager. Who will pay for their cars, houses
and yachts? Thousands of jobs in the industry are redundant and completely
useless to an investor. As one book from the 1940s asks, "Where
are the Customers' Yachts?";
Stock prices move
randomly and reflect the daily fair market value of each stock. Therefore,
the only hope of success for stock pickers is luck or chance. Time and
money are too precious to waste on stock picking. The best investment
strategy is to own a global, tax-managed, and diversified portfolio of
index funds matched to risk capacity. If investments are not on the optimal
returns line between risk capacity and risk exposure, then the appropriate
market rate of return will not be achieved.
Simply put, stock picking is expensive speculation with negative expected returns relative to a blended benchmark. The best advice is to just let go of it, forget about it, stay away from it, and find something more productive to do.
1. The performance of stock pickers must be examined on an adjusted basis. When comparing a stock picker's portfolio to an index, which factors must be considered before determining if the stock picker has beat the index?
proper accounting of returns, including cash flows in and out of the account
2. One of the problems of stock pickers is:
a. They focus on well
3. Stock pickers pay more taxes than indexers, because:
a) their annual returns
4. Stock pickers are often compared to:
a) chimpanzees throwing
darts at the stock page
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