Trailing Stops and Tax

by | May 14, 2015 | Archives

A recent article at this site Investing Spurts showed how one of my investments that turned 100,000 Danish kroner into 357,679 Danish kroner could have grown to 1,156,069 Danish kroner instead if I had tracked the Magic Calculator.

A reader sent this response.

Hi Gary.  Great article!  Your Jyske Bank example does indeed show how much better one can do using an effective trading algorithm than buy and hold.  Almost more importantly, you can avoid being really buried if you get into a company that gets in big trouble, by getting out early based on a judgement you don’t have to be emotional about. This advice could really boost some readers returns if they take it.

However your calculations are extremely biased because you didn’t adjust for paying cap gains taxes on your trades. Please recalculate and see  the difference. The compounding of  gains works quite differently. You shouldn’t rely on this kind of unreal calculations to make your point more dramatic.  The difference is still striking though offhand your total return might be up to 50% less – just a wild guess. Depends on your marginal tax rate for the one short term trade. This example may be quite exceptional in that the stock movement lined up right so that almost all the trades are long term. But even at that, pay for all the taxes out of the gains and what is your net return?  Best Regards,

That reader’s point is a good one.  I am remiss when it comes to share investing and taxes because all of my investments are made via my pension.  The tax man gets his bite when we take our minimum required distribution, but this allows us to let our investments compound in the pension.

One great benefit of having your own self publishing micro business without employees is that you can form a Chapter C corporation and set up a defined benefit pension plan.

Merri and I were able to dramatically reduce corporate taxes by creating corporate losses via pension contributions.

Because we are conservative investors, we were not clobbered in either the 2000 (we shifted into low yield Scandinavian bonds) or 2008 equity meltdown (we shifted into high yield emerging market bonds) so our only problem when we neared retirement age was that the pension was over funded.   We had to increase our salaries (to increase our minimum distributions) and pay taxes on all of that for a while!

At retirement age, we rolled the Defined Benefit Plan into a self managed 401K Plan.  Because our business still generates income we keep distributions at the minimum so I don’t think a lot about the tax consequences on equity investments.

I’ll write more about the tax planning because over the years it allowed us to build up a comfortable nest egg.  I know that the fed will eventually get its due, but this does allow us to defer and compound for many years.

I thank that reader for reminding me that not everyone has been able to create a good tax deferral program or they have so much money that cannot contain it all within their pension.

A self publishing micro business that allows you to create a pension is one good way to enhance your wealth at the expense of the tax man.

Gary

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