Making the Most of Your Stock Market Investments

Question: Two people invest $1,000 in the same stocks. One of them ends up with more than double the profit. How could this be?

Circumstances: Each investor puts $1,000 into the stock market for 20 years.

The Difference: The first investor holds Stock A for 10 years before switching his funds to Stock B for the next 10 years. The second investor switches between these stocks frequently. Despite their different strategies, each achieves 15 percent growth annually in the price of the shares they hold. (An excellent performance.)

Performance
  • The first investor's $1,000 grows to $16,367.
  • The second investor's $1,000 grows to $6,789.
Where did the Second Investor's Money Go?
People who buy and sell shares frequently in New Zealand are classified as traders by the Inland Revenue Department (IRD). Their profits are taxed annually.

For the sake of argument, let's suppose all of the investment growth above is capital growth (no dividends) and that growth is constant at 15 percent each year. (In reality, of course, some years will be better than others.) If the second investor is a standard rate taxpayer, who buys and sells shares frequently, his/her profits will be taxed at 33 percent each year.

Under these circumstances, the initial investment of $1,000 grows to $6,789, compared with the tax-free return of $16,367.

Conclusion:
Unless you possess extraordinary stock-trading skills, you will grow your net worth more effectively by buying and selling shares infrequently. Infrequent buying and selling allows you to benefit from tax-free growth and has the further benefit that you will pay less in brokerage fees, further enhancing your final return.