Friday, June 10, 2016

Is an Investment Tax Good for Investors?

Two Treasury Bond Scenarios

1. The government can buy its own Treasury bonds until rates fall by 1%.
2. The government can impose an annual 1% tax on Treasury bonds so the effective yield falls by 1%.

To newer Treasury investors, both scenarios feel the same. 1% of the yield has vanished.

It doesn't end there though.

Two Stock Market Scenarios

1. These newer Treasury investors can buy stocks instead, just like the Fed had hoped, pushing dividend yields lower.
2. The government can impose an annual tax on stocks so the effective dividend yield falls by that same amount.

To the newest stock market investors, those investing today, both scenarios feel the same. Some of the dividend yield has vanished.

Today's newest bond and stock market investors, who did not participate until now and therefore did not receive any price appreciation due to the Fed actions, are now basically experiencing a seemingly permanent tax on their investments. Both bond yields and dividend yields are lower just like they'd be if they were taxed.

I am not a newest investor. I locked in rates before they fell. Bond prices have gone up. So let's talk about how much better off I will be because of the Fed's actions.

Not one bit better, just not significantly worse. How can this be you ask? My bonds have gone up in price! Surely I must be better off! Surely I can spend more money frivolously!

Nope. Can't spend even a penny more.

The bonds I purchased pay the same interest they did when I bought them. There is no bonus interest. I planned to hold to maturity. I still do. At maturity, there will also be no bonus price appreciation. I'll get exactly what I was expecting when I bought them in the first place. The temporary price appreciation they have now will not help me, even by so much as a penny. Nothing the Fed has done has added to the prosperity of my long-term Treasury bonds.

It gets worse though. As my bonds mature, I immediately become a newest investor and I will see an investment world where both bonds and stocks are experiencing the equivalent of extra taxation.

So how on earth is this "taxation" supposed to make me more prosperous over the long-term? I have a simple answer.

It isn't prosperous. It's preposterous!

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