Yesterday I looked at the upper end of scalability, today I take a simple look at the lower end, again with my “strategy X.”

In the hands of a fund using all qualifiers, it holds 344 stocks on average, with 18% monthly turnover. Let’s say that, when holding only the top 20 stocks sorted by characteristic Y, “Joe Schmuckatelli, Retail Trader” experiences 25% monthly turnover in his account.

That’s 5 round trips a month, or 120 trades a year. If “Joe Schmuckatelli, Retail Trader” pays $10 per trade, that’s a $1,200 commission drag annually. Interesting, but useless out of context. More information is needed, such as the size of “Joe Schmuckatelli, Retail Trader’s” account, his tax rate, and the performance of the system.

Let’s say the system generates 15% average compounded annually – and that Joe could get 10% with very low volatility from a simple diversified buy+hold indexing across several asset classes.

Since tenure in this system averages under a year, let’s say “Joe” pays 25% of net in taxes.

Now let’s assume “Joe” has a $10,000 account – he would make $1500, pay $1200 in commissions, and be well behind buy+hold, even pretax.

With a $50,000 account, “Joe” makes $7500, pays $1200 in commissions and $1575 in taxes on the short-term gains, netting $4725, which is just below taxless buy+hold.

With a $100,000 account, “Joe” makes $15,000, pays $1200 in commissions and $3450 in taxes, netting $10,350 – just above what he could get from a taxless buy+hold.

There are lots of moving parts, not the least of which is that buy+hold isn’t taxless or commission-less; tax is deferred in some accounts, and is at the long-term capital gains rate, and there would be some expense for the reinvestment of dividends and initial buy-in. Also, one might take umbrage (I believe incorrectly so) with a low-volatility 10% average annual gain for diversified indexing across several asset classes. Finally, one can do better than $10 per trade on 120 trades/year.

The key points about scalability are: there are systems that can’t handle a lot of money, there are funds whose choices of method are hampered by their assets, and even retail schlumps need to pay attention to the scalability (down!) of their methods.