Financial Effectiveness Repository

Gunnar_Zarncke

Follow-Up to: A Guide to Rational Investing Financial Planning Sequence (defunct) The Rational Investor

What are your recommendations and ideas about financial effectiveness?

This post is created in response to a comment on this Altruistic Effectiveness post and thus may have a slight focus on EA. But it is nonetheless meant as a general request for financial effectiveness information (effectiveness as in return on invested time mostly). I think this could accumulate a lot of advice and become part of the Repository Repository (which surprisingly has not much advice of this kind yet).

I seed this with a few posts about this found on LessWrong in the comments. What other posts and links about financial effectiveness do you know of?

Rules:

Each comment should name a single recommendation.
You should give the effectiveness in percent per period or absolute if possible.
Advice should be backed by evidence as usual.

General Advice (from Guide to Rational Investing):

Capital markets have created enormous amounts of wealth for the world and reward disciplined, long-term investors for their contribution to the productive capacity of the economy. Most individuals would do well to invest most of their wealth in the capital market assets, particularly equities. Most investors, however, consistently make poor investment decisions as a result of a poor theoretical understanding of financial markets as well as cognitive and emotional biases, leading to inferior investment returns and inefficient allocation of capital. Using an empirically rigorous approach, a rational investor may reasonably expect to exploit inefficiencies in the market and earn excess returns in so doing.

So what are your recommendations? You may give advanced as well as simple advice. The more the better for this to become a real repository. You may also repeat or link advice given elsewere on LessWrong.

Follow-Up to: A Guide to Rational Investing Financial Planning Sequence (defunct) The Rational Investor

What are your recommendations and ideas about financial effectiveness?

I seed this with a few posts about this found on LessWrong in the comments. What other posts and links about financial effectiveness do you know of?

Rules:

Each comment should name a single recommendation.
You should give the effectiveness in percent per period or absolute if possible.
Advice should be backed by evidence as usual.

General Advice (from Guide to Rational Investing):

Capital markets have created enormous amounts of wealth for the world and reward disciplined, long-term investors for their contribution to the productive capacity of the economy. Most individuals would do well to invest most of their wealth in the capital market assets, particularly equities. Most investors, however, consistently make poor investment decisions as a result of a poor theoretical understanding of financial markets as well as cognitive and emotional biases, leading to inferior investment returns and inefficient allocation of capital. Using an empirically rigorous approach, a rational investor may reasonably expect to exploit inefficiencies in the market and earn excess returns in so doing.

I get a very different result when I run these numbers. I'm not from the UK so I may be interpreting the tax rules incorrectly, but here's the logic chain I used to model it (year one, so that it can be duplicated and logic verified);

If I invest 100,000 and pay the .5% stamp, I actually invest 99502.49
Dividends for the year would be 1990.05, of which I lose 746.27 to tax, leaving 1243.78 for reinvestment
Expected capital gains would be 4975.12 (99502.49 * 0.05)
Reinvesting the dividends of 1243.78 loses 0.5%, leaving 1237.56
Expected value at end of year 1 is 105715.2 (99502.49 + 4975.12 + 1237.56)

At the end of year ten, I expect 182334.10 in my account, which I then sell/crystallize.

The amount of tax I would pay is based on the "adjusted cost base" (google couldn't answer what term is used in the UK, but basically the amount paid for the shares). I work this out to be 118275.5, essentially buying the dividend-reinvested shares at the expected 5% growth rate during the 10 years. I then subtract the total stamp taxes paid, which I work out to be 580.43. This gives me a tax burden of 182334.10 - 118275.5 - 580.43 = 63478.17. I then deduct the 11,000 capital gains allowance. This results in a tax payment of 52478.17*0.28 = 14693.89.

Final net value of the sale is therefore 182334.10-14693.89 = 167640.21

In real terms, this is 134996.70, or a real rate of return of 3.2%

I believe the major difference in our numbers comes from the tax rate on gains.

In terms of sensitivity, I get a return of 4.84% with zero taxes (dividend and capital gains), whereas an increase to 9% (each div and cap rates at +1%) expected return gives 4.2%. This is under the assumption of the worst possible tax rates and scenarios (full sale at maximum rates). There are lots of timing methods to reduce the tax impact.

Granted, this is based on my knowledge of Canadian taxes, but I verified the UK equivalents as best I could and the differences are primarily in the stamp taxes. Most of the data is from https://www.gov.uk/tax-sell-shares/work-out-your-gain (and the related links).

It is very possible made a mistake in my spreadsheet. The numbers were intended for illustration only. Thanks for the correction.

You make a good point regarding timing taking gains. This is another way that thinking about tax can be very important.