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In the late 1980s Warren Buffett was in full educational mode: trying to help fellow investors avoid common errors; recounting cautionary tales at Berkshire’s AGMs; talking to MBA students; TV appearances, and; through his annual letters to shareholders.
One of the issues preying on his mind in 1989 was the mistake of rapidly changing the constituents of a portfolio – many so-called professional fund managers can have a churn rate (proportion changed) of over 100% over 12 months.
By starting out with the intention of holding shares in your portfolio for many years you can achieve much higher returns. This comes not only from a much better mind-set which is focused on the long-run prospects of the underlying business rather than stock market short term obsessions, but also from savings on transaction costs and taxes on capital gains made.
And then there are the human relationship issues of building up long-term friendships and understanding with business managers.
Buffett in his 1989 letter asked us to consider the extremis position of buying shares holding for one year after making a 100% return over those twelve months to illustrate his point.
“Imagine that Berkshire had only $1, which we put in a security that doubled by yearend and was then sold. Imagine further that we used the after-tax proceeds to repeat this process in each of the next 19 years, scoring a double each time. At the end of the 20 years, the 34% capital gains tax that we would have paid on the profits from each sale would have delivered about $13,000 to the government and we would be left with about $25,250.
“Not bad. If, however, we made a single fantastic investment that itself doubled 20 times during the 20 years, our dollar would grow to $1,048,576. Were we then to cash out, we would pay a 34% tax of roughly $356,500 and be left with about $692,000.
“The sole reason for this staggering difference in results
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