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Hold for the Long Haul
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Never forget that buy stock is a major purchase and should be treated like one. You wouldn't buy and sell your car, your refrigerator, or your DVD player 50 times a year. Investing should be a long-term commitment because short-term trading means that you're playing a loser's game. The costs really begin to add up—both the taxes and the brokerage costs—and create an almost insurmountable hurdle to good performance.

If you trade frequently, you'll rack up commissions and other expenses that, over time, could have compounded. Every Si you spend on commissions today could have been turned Into $5.60 if you had Invested that dollar at 9 percent for 20 years. Spend $500 today and you could be giving up more than $2,800 20 years hence.

But that's just the beginning of the story because frequent trading also dramatically increases the taxes you pay. And whatever amount you pay in taxes each year is money that can't compound for you next year.

Let's look at two hypothetical investors to see what commissions, trading, and taxes can do to a portfolio. Long-Term Lucy is one of those old-fashioned fuddy-duddies who like to buy just a few stocks and hang on to them for a long time, and Trader Tim is a gunslinger who likes to get out of stocks as soon as he's made a few bucks (see Figure 1.1).

Lucy invests $10,000 in five stocks for 30 years at a 9 percent rate of return and then sells the investment and pays long-term capital gains of 15 per­cent. Tim, meanwhile, invests the same amount of money at the same rate of return but trades the entire portfolio twice per year, paying 35 percent shortterm capital gains taxes on his profits and reinvesting what's left. We'll give them both a break and not charge them any commissions for now.

After 30 years, Lucy has about $114,000, while Tim has less than half that amount—only about $J4,OOO. As you can see, letting your money compound without paying Uncle Sam every year makes a huge difference, even ignoring brokerage fees.

And since holding a single stock for 30 years may not be realistic, let's consider "what happens if Lucy sells her entire portfolio every five years, reinvesting the proceeds each time. In this case, she winds up with about $96,000—which is not much less than $114,000 and is still much more than Tim's $54,000 (see Figure 1.2).

These examples look at just the tax impact of frequent trading—things look even worse for the traders once we factor in commissions. If we assume that Tim and Lucy pay $15 per trade, Tim nets only about $31,000 after 30

Long-Term Lucy: Holds stocks for five years, pays long-term taxes $95,994
Trader Tim: Trades stocks every six months, pays short-term taxes

Figure 1.2 Lucy decreases her holding period to 5 years from 30 years, but the benefit of lower taxes and a longer compounding period still nets her significantly more than Tim. Source: Morningstar, Inc. years and Lucy nets $93,000, again assuming she holds her stocks for five years (see Figure 1.3),

The real-world costs of taxes and commissions can take a big bite out of your portfolio. Extending your average holding period from six months to five years yields about $62,000 in extra investment returns. Lucy gets a lavish reward for her patience, don't you think?

One final thought: To match Lucy's $93,000 portfolio value, Tim would need to generate returns of around 14 percent each year instead of 9 percent. That's the true cost of frequent trading in this example—about five percent­age points per year. So, if you really think that churning your portfolio will get you five extra percentage points of performance each year, then trade away. If, like the rest of us, you were taught some humility by the bear market, be patient—it'll pay off.

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