SHARPE INCOME … Capital Additions!

Posted on Jun 8 2015 - 11:43am by Sharpe Trade

The original Sharpe Income post can be found here.

The Sharpe Income category be found by clicking on that red ‘Sharpe Income’ tag next to this post title, or by clicking here.

We continue the discussion from the last entry.

This is something we recently mentioned in one of our recent “How to Begin” entries.

That is, the idea of regular capital additions.  For new folks, this concept is vitally important to grasp.

And yes … we know we have discussed this concept a few times.  We talked about it recently in the “How to Begin” entry, mentioned above.  We have written on this concept in previous Sharpe Income entries.  We have mentioned it in podcasts.

Yet time and time again, we find that new investors seem to shy away from this concept … believing that to add capital to one’s account on a regular basis is ‘cheating’.  Or perhaps new investors underestimate the importance of adding capital to an account.

Let’s take that first false notion.  The idea being that it is somehow ‘cheating’.

Listen … in the professional sphere, let me tell you … firms and institutions are interested in adding capital from outside sources.  Or what about every 401k in the United States?  They are powerful because of the capital contributions, made by the employee, the employer, or both.  So why would any new trader try to behave in a way that professional firms do not?  Why should any new investor shy away, thinking perhaps that to add capital is a way of ‘cheating’?

That simply does not make any sense.

Perhaps they mistakenly believe that we count capital added into the account as part of the performance of the account.

But we can’t.  No one does this, unless they are cheating on their performance reporting.  You will note in the Sharpe Income spreadsheet, and the PDF, that we do not count the capital added to the account, as part of the performance of the account.

So how exactly is adding capital ‘cheating’ again?

Now let’s explore the second problem, in that we see new investors under-estimating the importance of capital additions.

As we mentioned in a previous Sharpe Income entry, capital contributions provide you with an incredible amount of maneuverability.  But perhaps to underscore the concept, let’s have an example, or illustration.

In example A – Let’s say you have $1,500.00, that you decide to invest.  So you invest $700.00 in an income stock, and $800.00 in some sort of bond exposed instrument.  Both pay you a dividend.

In example B – Let’s say you again, have $1,500 that you decide to invest.  However, you also add $50.00 every week to your investing account.  You also invest $700.00 in an income stock, and $800.00 in some sort of bond exposed instrument, and receive dividends from both.

After 6 months, the stock market market takes a dive, and at the same time, the bond market is expecting and receives an interest rate hike, so bond prices fall as well during a ‘re-adjustment period’.

The investor with example A, just has to ride out all of that draw-down, collect some dividends, and hope a scenario of tail risk does not develop wherein the situation deteriorates further and he is left simply ‘hoping’ that things turn around.   This investor has no maneuverability.  He or she cannot take advantage of new situations that develop.  They cannot evaluate their positions positions to see if they financially remain stable, and if so, average down on that position.  They simply have to hold on … and well, that’s it.

Whereas the investor with example B?  Has another $1,300.00 to invest after 6 months.  Nearly the amount of what they initially invested!  They can choose to average down on existing positions.  Or wait to evaluate the situation in which case they will have even more funds to invest … adding to their ability to maneuver.   Heck, they can do both!  Both average down and to improve their cost basis on a stable instrument, and then as capital is added, again evaluate the environment.

Capital additions.

Do not under-estimate it’s importance.  For both Sharpe Income projects such as this one, and even trading accounts!  When I first began trading, I added $35.00, each and every week.

‘Sharpe Income’ Actions This Week

For the purpose of this project, we now have $314.30 in total that is available, that is ‘segmented’ into a few different categories.  Here is what we are concentrating on this week …

Remaining Cash after Reservations: This week, I am contributing the entire $25.00 weekly deposit towards this category.   At the present time, we have $259.20 available for any instruments purchase.  At this stage of the game, we generally want equal sized purchases of near about’s, $300.00 or so. Once again … I have the purchase of a stock for this project on my radar.  It’s pulled back nicely, and I want to make sure I have the cash to purchase more shares when the time is right.  More on which stock this is later.  For right now, we only have a few more capital contributions, before the capital is available to do this.

The link to the Google Drive Spreadsheet that you can view, that we will edit, build upon and refer to over time can be found at this link.

We continue the Sharpe Income project with this next entry.

The Sharpe Income PDF breakdown for Week 28 can be found here …

5 Comments so far. Feel free to join this conversation.

  1. James June 8, 2015 at 2:00 pm - Reply

    What about when your account is bigger and you have to pay taxes on the profits you are making are you taking money out of the account to pay this?

    If so do you count this money your taking out to pay taxes as draw down?

    Won’t this impact your performance meaning you have instantly hit and gone past your draw down kill switch if in your case Dan you keep it tight (around 5% i believe you said)?

    • Dan Shy June 8, 2015 at 2:45 pm - Reply

      Heyya James,

      Thanks for the comment, good to hear from you.

      At this stage of the game … we’re still growing this particular income account. But this is an income account, which means it differs from a trading account. Taxes do not need to be paid if A) The Income Account is specified as an IRA here in the United States. At all. While it is growing, as long as it is kept in an IRA, taxes do not need to be paid. Not on the dividends and not on the stock itself. Even if it is B) not in an IRA, then according to my limited non-legal understanding (best to consult a tax consultant or a lawyer) then the taxes are paid on it every year, but only on the dividends. As long as you do not SELL the investments like CL, or UNP or IBM or AXP, then you don’t have to pay taxes on the actual stock itself. Only if you sell it. You only have to pay taxes on the dividends. Incidentally, taxes on dividends are about the lowest tax rate there is.

      Yes, at that point, once it is grown, you have to pay taxes on the income from the account. Just like any business. You make money by owning a restaurant, you have to pay taxes. No, at that stage of the game, I would not count the money taken out of the account as drawdown. Why? Because once at that stage, it’s one source of income. If I’m making $4,000 a month in dividends, and I only take out $3,000 that month as take home pay, my account is still net positive by $1,000.00. So although that would mean a hit on my yield on cost of each stock … it would not mean that I would really have drawdown, or run the risk of ruin.

      And remember, this is an income account, not a trading account. My trading accounts have the general rule that I don’t like 5% drawdown before I get defensive. That doesn’t mean that even my trading accounts won’t see 5% of drawdown. It’s at that point I get very defensive, but I can go beyond 5%. In fact, in my short-term trading account (not my valuation accounts or my side-pockets), I’m beyond 5%. That’s simply the kill-switch to when I get defensive. But even defensive strategies have draw-down.

      Regardless, that’s the trading accounts. Not an income account. An income account is a completely different affair.

      (Here’s a little picture of how my accounts are organized: )

      I’m more flexible with an income account, because these positions will not be sold. And, I have the flexibility, like we mentioned in this post … of capital additions. Since it is income, I don’t have a draw-down kill switch on an income account. And as stated, I’m more flexible than I am in my risk parity portfolio anyways.

      Hope this answers your question, but if it does not, please feel free to ask more questions, that’s what we are here for.

      Sharpe Trade, LLC

  2. James June 8, 2015 at 4:52 pm - Reply

    Hello Dan and thanks for responding!

    From what I can gather then does this mean you would use the fixed income account to pay all taxes for the three valuation, trading and tier capital sisters?

    Let’s say for example your trading account balance is £300,000 and is up 20% at the end of this year and this 20%=£60,000

    Where I’m from you would have to pay around £17,870 as tax. That means if you used your trading account to pay this tax your immediately down by roughly 6%…

    On the other hand if you were using the fixed income account to pay your taxes it would have to be generating a huge amount of income to pay taxes on both itself (the Sharpe income account) as well as the three sisters in your portfolio…

    The problem I’m seeing is if all of a sudden your trading account is up at the end of the next year by 90% your income account will start lagging behind your trading account when it comes to being able to maintain paying the trading accounts taxes…

    I hope Dan you understand what I’m trying to say with regards to the problem I’m seeing with Portfolio Performance and taxes.

    I just want to know what’s paying for each sisters taxes? Is each sister paying its own taxes individually or is the fixed income account paying for everything?

    • Dan Shy June 8, 2015 at 6:20 pm - Reply

      Heyya James … 🙂

      Myself personally?

      No. I don’t use specifically my Fixed Income accounts for all of my taxes. I’m a guy that likes to “collect” 🙂 revenue sources, or sources of income.

      I have Fixed Income accounts.

      There is YouTube income from my ol’ AileronTrading channel (which, I’ll probably end that income stream).

      There are other businesses with which I am involved either as a partner or just receive income from them, including Sharpe Trade, LLC, that provide me with income.

      I’m a big one for getting income from many sources, that I may not have to do a lot of “work” per se. 🙂

      The point being, is no, I actually have a number of sources of income that I use to pay my taxes. And it’s rare that I’d take money out of a trading account to pay for the taxes. Here in the States, we have to pay annually, but generally, it’s a good idea to set money aside each quarter to pay the taxes when they come due.

      As far as income itself, if one can get to a place (and there are several tricks I plan on demonstrating with this project, once it grows, to get it there more quickly) where you’re being paid $4,000 a month in dividend income … then you can do pretty well off of that, as I live simply. One could simply take $3,000 a month, leave a $1,000 in dividend income, and that remaining $1,000 is still growing the dividend account. $3,000 could pay for the taxes and still have income each month.

      But like I said, I like a few sources of income, not just a Fixed Income / Dividend account. So if an account can get to a place where it’s generating $3,000 in income, and there are other sources where you’re getting $3,000 or $4,000 a month?

      Taxes aren’t really a concern.

      Truth be told … I rarely think about them.

      Sharpe Trade, LLC

    • Dan Shy June 8, 2015 at 6:26 pm - Reply

      As well, keep this in mind, once started, returns are non-linear. It becomes very difficult to compute, in a linear manner, the way the growth will actually occur.


      Although, like I said, in the future, I’ll be sharing several tricks.

      Sharpe Trade, LLC

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