Seeking Alpha
Profile| Send Message|
( followers)  

Despite many pundits stating that "buy and hold is dead," I continue to believe that it is an optimal way to achieve great long-term returns. Therefore, my own portfolio is comprised mostly of positions that I intend to hold on to for at least several years, with only a small minority dedicated to opportunistic trading.

There are several tax advantages that a buy-and-hold investor has over investors with shorter-term time horizons and traders. For instance, should qualified dividends continue to be afforded preferential tax treatment, investors who hold their shares enjoy a much more favorable tax status on their dividend income (15% vs. 35% rates at the top tax bracket).

Even more advantageous than preferential dividend tax treatment is the fact that unrealized gains are not taxed at all, and long-term capital gains are taxed at a lower rate than ordinary income (15%). Contrast that with traders who face paying tax on their short-term gains at the rate of 35%.

For instance, take these theoretical scenarios:

Scenario 1 -- Swing trader who returns 10% annually on his or her trading activity.

Scenario 2 -- Investor who has unrealized gains of 5% annually and dividend income of 3% annually, which is reinvested.

You'll note that I'm actually giving trader the edge, return-wise, though I don't think there is any evidence that actually shows traders generate superior returns to long-term investors over extended time periods. But I'll cede to the future arguments and provide the trader that little bit of an edge.

With a $10,000 account (feel free to add or subtract zeroes until the number has relevance to you), after one year the trader will have earned $1,000 in trading profits and paid tax of $350 (assuming the trader was in the top tax bracket) for an ending balance of $10,650. The investor will have collected dividends of $300, of which he or she will owe $45 of tax and will have seen capital appreciation of $500, giving the investor an ending balance of $10,755.

After one year, the investor (who, in this case, is returning a full two percentage points less than than the trader) earned an after-tax return of 7.55% vs. the 6.5% earned by the trader. Take that scenario out 20 years, and the trader will have brought his or her original $10,000 account up to $35,236.45, while the investor's account will then be $42,875.41.

The math works in the buy-and-hold investor's favor.

When surveying the universe of potential investments, nearly any security can be bought with confidence that it will be around the following day. Other companies may be especially compelling in today's market conditions -- such as my current favorite, American Capital Agency (NASDAQ:AGNC) -- but will face uncertainty as those conditions change. Looking further out, the number of securities that one can believe with confidence will continue to exist in 10 years becomes dramatically smaller.

I believe the following are good examples of companies that have entrenched themselves in their markets deep enough that there is almost no question as to whether they will survive or not:

Philip Morris (NYSE:PM), a very boring company in a boring industry. If it weren't for fear of an avalanche of lawsuits, it could just about boast that its current customers are hooked on their products, ensuring current and future sales.

Federal Express (NYSE:FDX) and United Parcel Service (NYSE:UPS), leaders in overnight delivery services. Both have built an infrastructure that simply can't be recreated overnight. Moreover, they have considerable name recognition and brand loyalty. Even if a new player appeared on the scene and offered the same service for a 10% discount, I don't think it's likely that it would garner much business. When you're shipping an important document for execution on the following day, very few people are going to question a charge from FedEx or UPS.

Hershey (NYSE:HSY) and Coca-Cola (NYSE:KO) are two other examples of businesses that are well-positioned to survive the test of time due to their dominant positions in their respective industries and the brand loyalty they have generated for themselves.

Other companies I considered, but could not include in the short list above, are:

American Capital Agency, which, admittedly, is by far my largest holding. But I think the investment environment that has benefited mREITS the last several years is not going to last indefinitely. Therefore, I would not feel comfortable buying shares with a decade or longer time frame in mind. Additionally, since American Capital distributes all of its earnings as ordinary income, it is not optimal for a taxable account if you're trying to minimize taxes and maximize compounding potential.

Intel (NASDAQ:INTC), which has a dominant position in the market for desktop and server processors and chipsets. Its chips don't seem to be getting taken up in the mobile market, and as more and more users shift from using desktops and laptops to smartphones and tablets, that may not bode well for the company.

Apple (NASDAQ:AAPL), which I own currently. However, I am not comfortable making guesses about its long-term future. It's true that right now, it's one of the most well-run and profitable companies out there. But as it saturates its own market, it's becoming a challenge to see where the future growth will come from.

Disclosure: I am long AGNC and AAPL. I am seeking to open a position in PM if the price becomes more favorable. I have no positions in FDX, UPS, HSY or KO, nor do I intend to open any in the next 72 hours.

Source: Stocks For Forever