Wise Wealth Advisors

D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Less churn more gain

Posted by Muthu on April 9, 2018

We are in the process of sending each one of you annual portfolio summary along with our review. We plan to complete the work latest by last week of this month. For those of you who started investing after September’17, the review would happen only from the coming year. Since these investments are less than 6 months old, they become eligible for review only from the coming year.

I was reading Buffett’s annual letter of 1989. He has given an example which illustrates the importance of less churn and not interrupting the compounding unnecessarily.

“Because of the way the tax law works, the Rip Van Winkle style of investing that we favor – if successful – has an important mathematical edge over a more frenzied approach. Let’s look at an extreme comparison.

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. Interestingly, the government would gain from Scenario 2 in exactly the same 27:1 ratio as we – taking in taxes of $356,500 vs. $13,000 – though, admittedly, it would have to wait for its money.”

In both the cases the returns are same. When the portfolio is churned and tax is paid every year, the final corpus is $25,250. When the portfolio is not churned and the tax is paid at the end of 20 years, the final corpus is $692,000. A staggering 27 times difference.

Be it mutual funds or stocks, if no churn is not possible, we prefer less churn. The lesser we interrupt the compounding; the more would be the final gains.

The above example given by Buffett strengthens our conviction to keep the churn bare minimum.

Hope you would also agree.

One Response to “Less churn more gain”

  1. […] Less churn more gain (Muthu) […]

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