As I put the final touches on this year's tax return, I always pay extra attention to my Schedule D form. This is the form where investors list what they sold this year, along with the capital gains and losses earned. The form also requires you to separate your short-term gains and losses from your long-term ones.
Getting the short end of the stick
Out of curiosity, this year I decided I would go back a few years and examine my Schedule D for each year to see how the results stacked up over the years. What I found was both enlightening and frustrating.
Over the years, the substantial majority of my capital losses seemed to hang out in the short-term section of the form. Under IRS rules, short-term gains and losses are those which are held for less than one year. From what I could see, at least for myself, trying to "invest" in a business for less than a year rarely paid off.
Go long ... real long
Thankfully for me, most of my investments were classified as long-term. Here, the picture was much brighter. For my long-term holdings, I mostly had gains. Wonderful businesses like PetroChina
And even better, the IRS encouraged me to stick with them for the long haul. With lower tax rates for long-term gains, the IRS gets less of my profits when I hold my investments more than a year. So not only did I make more money by hanging out for the long term, but I also paid much less tax than if I had attempted to speculate and profit in the short term.
A valuable lesson
I'd bet that most investors -- if they looked back -- would notice similar results from their investments. Good businesses are not focused on the next quarter or two. They tend to provide strong performance over a period of years.
What really brought this lesson home for me was that most of my short-term mishaps actually became excellent long-term investments. For instance, I bought shares of Walter Industries
But when investors succumb to the short-term price swings, they shift their focus away from long-term business fundamentals to short-term stock volatility. As Ben Graham famously said, "In the short term the market is a voting machine, but in the long term it is a weighing machine." Thus, to focus on the short term would be akin to trying to catch a falling knife.
Prudent investors should only use short-term price volatility as a window of opportunity to buy good businesses at temporarily cheap prices. Then they should ignore the short-term noise and allow the business time to prosper. In time, the solid business fundamentals should overcome any short-term price slides.
It's not often that one finds something pleasant to say about the IRS, but they do pay you to wait by taxing your long-term profits at lower rates than short-term profits. And the truth is that the real money in stocks is made over multi-year periods.
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