One should figure out the impact of taxes and brokerage costs if you think your trading or stock-picking skills can beat the index, notes Devangshu Datta
He wrote an interesting series of columns recently.
He took two columns to compare returns for a great trader versus a passive index investor with a systematic investment plan.
A third column looked at a good timing strategy versus the same sort of SIP.
A fourth column looked at great stock picking results versus SIPs.
These were US-specific.
The tax element is different and so are the specifics of returns.
However, the points raised are globally relevant and worth consideration even for a desi retail investor.
The calculations showed that a trader who outperformed the passive strategy consistently by as much as 4 per cent per annum would only break even versus the passive American investor.
This is due to the impact of short-term capital gains tax.
Tax mops up about one-third of annual trading profits, while an SIP has zero tax and steady compounding.
If you factor in brokerage costs, the differences are even more in favour of the SIP.
There are major differences in the two tax regimes.
India has a lower effective short-term capital gains tax rate, zero tax on long-term capital gains and zero tax on share dividends (the US has taxes on both).
There are also big differences in the carry forward of speculative losses and the treatment of derivative profits and losses as business income and expense.
But the principle is the same: a trader must outscore a passive player consistently, by very large amounts to beat the passive systematic investor in the long-term.
In fact, the specifics of Indian market returns and Indian tax policy imply that the Indian trader needs to beat the India index returns by even larger margins per annum.
The WaPo timing strategy assumed that the 'timer' buys the index after steep corrections.
This is sensible on the surface.
But it doesn't work well compared to a SIP.
The flaw is that there are long periods when a timer doesn't add to equity exposure
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