Much has been made about buy and hold passive investing outperforming active managers. A lot of the argument revolves around lower tax rates on capital gains. Taxes are never good and all things being equal a lower tax rate is always better but MOST investors overestimate the benefits. The fact is that a manager would only have to earn 2% more on their returns at a 35% tax bracket to outperform someone paying the lowest tax rate at 15%. If an active manager can’t outperform the market by 2% or more, they should seriously look for other employment. Since 2001 the account we manage has outperformed by over 430%. Of course that doesn’t mean it’s a linear graph. We don’t beat the market every month and not even every year.
The table below shows the after tax returns on a $1 million at the lowest tax rate versus the highest tax rate. Buy and hold only cuts it if you can’t outperform. Otherwise it always generates less wealth than the alpha generator. That’s the fallacy of the indexer. Since most people can’t beat the market, they are better off to buy and hold with a lower tax rate but if you can outperform, there really is no reason to buy and hold just because of lower taxes.
