Before embarking on IBD, it’s important to understand price in the context of a market and not a specific asset class. It doesn’t mean you shouldn’t trade stocks – although if you don’t, please try to invest more time and effort into your portfolio. However, it’s important to know that prices in stocks are relatively insensitive to the size of your portfolio or the amount of your savings – even with a large investment (say, 5% of your assets).
To find the “cost” of IBD, it’s useful to look at the historical movements in an asset class. IBD moves around the market all the time. When the asset class falls in price, it’s because the broader economy’s fundamentals are starting to improve and/or the government is doing something good. When the asset class rises in price, it’s because the broader economy’s fundamentals are starting to improve (and/or the government is doing something bad).
So, to look at the cost of IBD as compared to S&P 500 stock index, I calculate the percentage increase in a given stock’s price (adjusted using the index-adjusted price of each index as a standard deviation) from a one-year historical high to a one-year historical low. This works out to 2.4% growth for the S&P 500, and 5.5% for the IBD. The S&P 500’s price increase is 1.3 points per year. And of course, the IBD’s price increase is 2.4 times the S&P 500’s value, so it takes 2.4 times the amount of value in the index to push its price upward by 1%. (If you’re interested, here’s the equation.)
The results for IBD, as compared to market stocks, are much less dramatic. For the S&P 500, the difference is less than 1%, and for IBD, the difference is 1.3 times as large (the IBD gain is 5.5 times the S&P 500 increase).
That means if you were investing $5,000 today, you would get $45,000 of tax-free interest. That’s 3.8% if you’re an IBD, and 5.3% if you’re a market. It’s certainly a nice result – but it does not mean you should be making huge sums of tax-free interest every year, and the fact of interest is that a) your interest isn’t taxed at
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