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How Magic of Compounding Can Make You Richer by 2641 Percent

See the Magic of Compounding
See the Magic of Compounding

Benefits of Compounding

  • Passive investing.
  • Stress free.
  • Save taxes.
  • More time available for family.
  • Improve quality of life.
  • Healthy as well as wealthy.
  • Less screen time.
  • Achieve more from less.

Charlie Munger
If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum.

In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15%— or only 9.75% per year compounded.

So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening.

If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.

Warren Buffett
Imagine that Berkshire had only $1, which we put in a security that doubled by year end 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 would be the timing of tax payments.

Rate of Interest100%
Tax Rate34%
End of YearBuy and Sell StrategyBuy and Hold Strategy
1 2 2
2 3 3
3 5 5
4 8 11
5 13 21
6 21 42
7 35 84
8 58 169
9 96 338
10 159 676
11 264 1,352
12 438 2,703
13 727 5,407
14 1,206 10,813
15 2,003 21,627
16 3,325 43,254
17 5,519 86,508
18 9,161 1,73,015
19 15,207 3,46,030
20 25,244 6,92,060
see the effect of Buy n Hold vs Buy n Sell Strategy on your Wealth
Effect of Buy n Hold vs Buy n Sell Strategy Wealth

How Wealth Increased by 2641%

In buy and sell strategy, our $1 becomes $25,244 while in buy and hold it becomes $6,92,060.
Profit = 6,92,060 – 25,244 = 6,66,816
Percentage = (6,66,816 / 24,244) * 100 = 2,641.48%

Buy and Sell Strategy
Frequent churning leads to more outgo of tax.

John Bogle
The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.

Warren Buffett
Investors should remember that excitement and expenses are their enemies.

Warren Buffett
Tax paying investors will realize a far, far greater sum from a single investment, that compounds internally at a given rate, than from a succession of investments, compounding at the same rate.

Moral of the Story

Compounding is rightly called the 8th wonder of the world.

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