The Rational Investor #016: Warren Buffett on Taxes & Long-Term Investing
Happy Saturday to you,
Welcome to the 16th edition of The Rational Investor Newsletter.
Today’s quote comes from one of my absolute favorite investing books that almost nobody I know has even heard of. The book is Warren Buffett’s Ground Rules: Words of Wisdom from the Partnership Letters of the World’s Greatest Investor. If you didn’t pick it up based on the subtitle, this book is a distillation of Buffett’s investor letters from his PRE-Berkshire days. It’s absolutely packed with investing wisdom and I believe it to be the most underrated investing book out there! High praise, I know.
Speaking of underrated investing books, if you have a book that doesn’t get the love you think it deserves, please share it with me by replying to this email…
Getting on with today’s programming.
In today’s quote (from Buffett’s letter in 1965—note the tax rates), Buffett explains the compounding effect of buy-and-hold investing vs. constant tinkering with your portfolio. I’ll have a slight bit of commentary to follow.
Onto the main event…
Here’s Buffett on Taxes and Long-Term Investing:
More investment sins are probably committed by otherwise quite intelligent people because of ‘tax considerations’ than from any other cause.
…
Consider two stocks, each compounding annually at 15% for 30 years (we’ll assume everyone’s capital gains rate is 35% to make our calculations easier). The investor who jumps back and forth between the two stocks each year will also have their gains taxed each year; the 15% pretax rate will slip down to 9.75% after tax: [15% x (1- tax rate) = 9.75%]; $10,000 invested today will be worth $150,000 in 30 years at this rate. Not bad.
However, if the investor instead holds just one stock for all 30 years and gets taxed just once at the end, they get the same pretax rate of 15% but the after-tax rate improves to 13.3%. The same $10,000 will compound at an extra 3.55% and will ultimately produce 2.5 times as many after-tax dollars after 30 years.
The deferral of taxes provides a form of financial leverage that allows the second investor to control more assets for longer.
The value of tax-deferral is astounding which is yet another reason we should advocate for buy-and-hold investing. This is also what makes it possible (probable?!) for a “good enough” portfolio to be more profitable than the constant chasing of a so-called “optimal portfolio.”
You might also note that this mathematical view of buy-and-hold investing is another vote for indexing since there is rarely any reason to change your diversified portfolio of index funds. Between compounding at market rates and the tax deferral, it’s an incredibly tough portfolio to beat over the long run.
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
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