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The hidden costs of a full time private trader

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skc

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On this forum you often hear people wanting to turn into a full time trader. They are attracted to the lifestyle on offer but also the financial rewards through compounding trading profits at a high annual rate. However, the reality can be very different. I've worked an example using John, the aspiring full time trader...

John is currently a full time salary man earning a $80k package per annum. He's saved up $250k of trading capital and has developed a system that returns 25-30% per year. So he's thinking... $250k x 25-30% = $62.5 to 75k which is a bit lower than his current income, but his salary income will only be growing at inflation of say 2.5%, whereas his trading income can compound at 25-30% p.a. So he will be making much more money by becoming a trader... Right?

The answer may surprise you (it surprised me a lot!)
 
If John stays a salary man...

Key assumptions. Inflation and income growth = 2.5%. Investment return on capital = 8%. Super contribution = 9% of salary. Super return = 5%. Annual living expense $35k growing at annual inflation. All surplus cash re-invested.

In year 0, John's earning a $80k package, while making $20k from his $250k capital. After paying tax and living expenses, he has $31.7k available for further investments.

By year 10, John would be earning $102k in salary, $52.8k from investment capital (which has grown to $660k) and has accumulated almost $90k in super.

By year 25, the numbers are $148k in salary, $108k from investment capital (which has grown to $1.84m) and $370k in super. His total asset would be ~$2.2m.

 
If John becomes a private trader and makes 25% p.a. for the next 30 years...

Key assumptions. Inflation = 2.5%. Trading return on capital = 25%. 4-week leave adjustment per year on trading return (to account for holidays and sick leave). Super contribution = 0%. Annual living expense $35k growing at annual inflation. Deductible expense = $3k per annum (growing at inflation). All surplus cash applied to trading capital.

In year 0, John made a trading income $58k. After paying tax and living expenses, he has $13.4k available to add to trading capital.

By year 10, John would make a trading income of $107k and has surplus cash of $41k to add to his trading capital (which has grown to $465k). He has $0 in super.

By year 25, the numbers are $450k in trading income, $192k from investment capital (which has grown to $1.8m) and $0k in super. He would have total assets ~$1.8m.

 
Here are the results in graph format.





And here's the shocking reality...

It took 18 years for Trader-John's after tax income to catch up with Salaryman-John, and 30 years to have the same total asset... despite making 25% return each year for 25 years.
 
So here are the 4 hiddens costs to a private trader.

1. Cost of capital - If you've saved up some capital, the alternate is to invest it. This compounds in itself and your salary income provides further free cashflow to add to this investment capital every year. This effect is huge over the long term even though the annual investment return is low (the example only assumed 8%). This is the real opportunity cost of trading.

2. Drag by tax and expense - You might make 25% trading return, but the tax man takes a large cut and you need food and have bills to pay. In this example, the actual rate of compounding for Trader John was only 5.35% in the first year. You will compound much slower than you thought/hoped.

3. Holidays and sickness - Salary income usually comes with 4 weeks of annual leave and 10 days of sick leave. Trade for yourself and you get none of that. You have no income when you get sick. You take a holiday and your annual return suffers. The example assumed Trader John doesn't trade for 4 weeks every year. This reduced his trading income from 25% to 23% p.a.

4. No automatic payrises - Most jobs enjoy payrises every now and then as income is adjusted to catch up with inflation. And if you are in a professional capacity, chances are your salary rise should go up much faster than inflation as you gain more skills and seniority. There is no such thing in trading. You have to increase every cent of income by yourself. In deed, inflation undermines you further as your living expenses increase every year without commensurate increase in income.

So if you are thinking of giving up your day job and become a full time trader, make sure you take all these into account, and ask yourself if you'd be better off in 5, 15 or 30 years time!
 
Wow, quite informative indeed.

Thank you a lot skc.

I've got started mainly because my position was redundant, so it wasn't really an option for me and it was a nice way to make money while I am still unemployed. Makes me want to go back looking a bit harder in the job market
 
Cup half empty

Throw in a few underperforming years
Then throw in a few negative years.

Cup half full

Throw in a few out performing years
Throw in a few outlier home run years.

It's a good post SKC

But like any business you can play with what ifs
All day. It's just a cash-flow analysis.
Any business can be likened to trading simply in a business
Sence.
Many fail
Some succeed ,some dominate , and some grow from
One man organisations to monoliths ( hedge funds ),

Its up to the entrepenerial and business skill of the
Business owner to firstly succeed and ultimately
Grow his business.
There will be a vast difference in results.

You'll also note that many very very good traders have other sources
Of income SOROS,WILLIAMS,SHWAGGER to name a few.
 
Interesting read. Thanks for the effort of putting that together.

My first thought is that it depends on:
1) your desires and passions - are you trying to maximize your net worth or do you value freedom more?
2) how many hours do you have to spend on trading per week to make that money?

If its only a couple of hours a day or less placing trades at night and flicking through charts (because you'd hope you'd be a very very good trader if you left your job) then why work an extra 40-50 hours a week which is most of your week, if you don't have to? It's a lifestyle choice.

Questions I'd ask myself:

1) how much do you enjoy your job?
2) what level of income (after expenses) do you need to enjoy the lifestyle you desire?
3) what is the opportunity cost of working? What would you do in your spare time? Is it worth it to YOU.

IMO it would be a different scenario is you had to spend 8 hours a day trading. Unless you really really enjoyed that more than your job (I'd find it boring I think) then I wouldn't stop working.

Another option is part time work. Anything from 2-4 days a week. Creates a more free lifestyle with some stable income coming in to contribute the the trading account which will compound nicely over the years.

Just my thoughts.
 
A wonderful post SKC.

The dream meets reality.

Opportunity costs, not between work and trading but how I approach the market is basically my major consideration.

I left work to trade full time and was probably never game to look back to see if it was the right move on an opportunity cost basis. But opportunity costs loomed large in my journey.

Some really important things I discovered (that apply to me)

Trading full time is really boring and isolating and takes as much time if not more than any other job. You can pick your hours, but end of the day you have to be present mentally and most likely physically (especially short term trading) to make the coin.

Trading was not scaleable. I could make a good return on X but I could not maintain that return as my balance grew.

I became more aware of the opportunity costs through general knowledge and those costs grew because I couldn’t personally scale my trading.

After a few years of trading my goal changed – I wanted my money to work for me – Not me work for the money. Assessing the opportunity cost I realised that I didn’t need to lift the return on all my funds by much to trounce whatever I could do with only a portion of the funds whist basically ignoring the rest.

My solution was to push out the holding period length to get the scalability – I went the whole hog to trade business trends. That was my choice because I had discovered my real passion was analysing the underlying businesses and it also offered the most lifestyle benefits, tax mitigation and risk mitigation in handing over a robust cash flow to the family if anything happens to me.
 

I don't believe it is realistic to expect anything less than full time equivalent hours if you are a private trader using your own capital... you may get by in a trending market doing breakouts for a few years, but when the market start to behave different you will need to find different strategies nice and quick, and you need to make up those losses incurred during the phase when the strategy didn't work for you.

And when you start to scale up and deal with more meaningful sizes - those odd 15R trades on the specie will only add 3% to your return as opposed to 30% because the liquidity simply isn't there. And with bigger size, you will start to micro manage your trades and orders to make sure you get reasonable fills. It's actually harder and much time consuming than I'd expect.

Trading for yourself is a workstyle choice with some minor lifestyle benefits. But don't expect to see it in hours worked.


Well put. The interesting aspect of opportunity cost is that, if you have a high level of trading skill, you'd likely have a high level of ability to understand the market. Yet the higher your ability to understand the market, chances are your opportunity costs would be higher as well. You sort of chase your tail a little bit in that sense

The issue of scalability is a difficult one but, all else being equal, the shorter your trading timeframe and the smaller the move you are trying to capture, the more difficult it is to scale up. A $250k account is a breeze to manage. At 10x that it's a completely different beast.

Back to the analysis...

Remember what is presented is simply a model to highlight the "hidden costs" that aspiring traders may not have thought about. Change some assumptions around starting capital, relative returns and living expenses and you'd get very different results. And like Tech/A said, a few good years at the start of the journey may see you do financially better in 2 years rather than 18 years.

Anyhow... I will talk about how to deal with these issues in my next post (when I have time).
 
Great post, as usual SKC.


CanOz
 
Great post, skc;

... and a very timely warning especially to those falling for the promise of easy money from a couple of hours' work.

I would also put a damper on the expectation of 25% profit p.a. While it is possible for some, the sad reality would suggest that the majority of traders struggle to achieve those results consistently. There will be years when "John" will have to access his capital to pay the bills. And it will be scant consolation that there won't be any tax to pay in such years.
 
Great posts SKC (and others), your efforts are appreciated.
 
Great post! But I do have a question - at what amount of capital does John end up 'better off' financially if he were to opt for the trading option. Given his salary is a fixed amount and his trading returns are proportionate to his starting capital, there's got to be a point where the result is very different.

(Sorry, I'm being extremely lazy and not doing the math)
 
An interesting exercise, skc, and thank you for doing it.

Such an assessment perhaps isn't always just going to be about the respective financial outcomes.
Certainly that's the main focus for people in the process of acquiring a reasonable level of financial security, but that achieved, imo the focus needs to shift more to what offers a less stressful (and therefore more healthy?) lifestyle.

I'd be interested to know who, when working out a life plan, sets a financial target and is prepared to ease off somewhat when that's reached?
 
Yep.

Just like the ratio between returns and volatility (RaR/Sharpe) there is also a ratio between returns and cortisol. If I can have 80% of the returns with 10% of the stress, I will (and do) take it.
 
tech/a said:
Tax is the killer.
Click to expand...

Tax is not the killer. You pay tax on salary and investment income much the same way you pay tax on trading returns. In fact, in the first year Trader-John had an effective tax rate of 16.2% while Salary-John paid 23.1%.

With trading there's actually a chance to structure yourself to be more tax effective but that's beyond the scope of this exercise.

The killer is the much lower compounding rate of Trader-John vs Salaryman-John. In year 0, Salary-John essentially compounded at 12.7% vs Trader-John at 5.3%. The causes for that are the 4 hidden costs of which tax is actually not a difference maker.


At ~$400k and all other variables being the same, Trader-John will be better off after 1 year.

Alternatively, if Trade-John goes for 30% return he'd be better off by around year 5.


Obviously we can't analyse life decisions on a spreadsheet (not all the time anyway). And this is not a life plan... it's simply a numerical model to highlight what may otherwise be neglected when one is considering the financial aspects of his/her decision.

To be honest had I stuck with my old profession rather than be a trader for the past 5 years, I'd be on a much higher income now (Assuming the normal speed of progression / promotion). But the stress and workload demand of that profession means that I would also have had multiple burnouts and probably be in terrible health. I also wouldn't be able to see and play with my two young kids everyday and feed them dinner at 5:30pm (I rarely finish work before 8pm in that job). That alone is worth $millions.
 
This is a very good thread.

I traded in a falling market, quite aggressively, buying and selling, on chart signals, often foregoing divies for my signals.

I only trade long.

I borrowed from St.George about $40000, with a similar of my own funds. My interest prepaid from memory was $3800 or thereabouts.

I had a reasonable expectancy on my trades, don't ask details, not my corner.

I had ten wins and two losses.

I made $4200 or thereabouts and about $500 on divies.

It was hard work.

I learnt heaps from it, on trading, margin trading and the zen of being in the game.

You do not only need to look at stocks but also at your margin, expectancy, costs, stops and targets.

It has helped me with my SMSF trading which is longer term.

Was it worth it?

Yes.

Did I make a huge profit?

No.

But I made a small profit in a bear.

It is very very difficult unless you catch a bull run, and I mean a bull run for 2 ears or more to make a quid from being a full time trader.

Trust this is useful.

gg
 
Great thread.

It does assume an either/ or, which is probably not necessarily correct.

If you have an occupation that supports you being able to trade for much of the time, then it could be a winner.

But a nice point of discussion nonetheless. At the end of the day, the message is the same: continue to grow your capital by all means (legally) possible.
 
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