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Bob and Bill (Trading Vs Buy and Hold)

Discussion in 'Shares' started by Hodor, 10th Oct, 2016.

  1. Hodor

    Hodor Well-Known Member

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    17th Sep, 2016
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    hodor
    Here is a little tail of compounding wealth.

    Bob and Bill were brothers who had an Aunt Dot who sadly passed away, in her will she left Bob and Bill $100,000 each. Bob and Bill had a discussion and both decided it would be a fantastic idea to invest the money.

    Bob is lazy, he knows that people make money on the share market but he has little interest in actually doing anything. He places all his money in an index tracking ETF, set the dividends to reinvest and forgets about it.

    Bill is a savvy fellow, he reads all about investing and works out he can double his capital gains return by trading! Sure once a decade he might not make any money for a year but he won't loose anything those years and for the other nine he would be making TWICE as much.

    For the next 20 years the share market ticks along much as it has in the past and returns capital gains of 6% and dividends of 4% (TSR of 10%).

    20 years later Bill looks at his trading account and is proud of how smart he has been. He has turned his $100,000 into just over $700,000!

    Bill calls up Bob and tells him how well he has done. Bob is worried, his sloth like behavior might have just cost him 100's of 1000's of dollars, he logs into his "trading" account and finds his ETF is now worth, just over $700,000.

    So what gives? Bill was getting capital gains of twice the market return (12%) and only had two bad years?

    Despite Bill achieving far better returns, Bob more effectively compounded his money - each year Bill had to pay capital gains taxes (from his trading account @ 37% on capital gains), Bob didn't. Bob also reinvested 4 dividends a year (1% each for 4%) as some ETFs pay.

    Yes this is an over simplified example. The example above ignores trading costs and gives him dividends for the full year, he is likely to miss out of many of these due to been in and out of the market. There are many other things one could add or remove to tell the story one wants and no one knows the future.

    The point of this tail is to show the disadvantage a trader faces over someone that just compounds their wealth effectively. I was actually surprised that my example put Bob and Bill just over $4,000 apart.