SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

The Magic of Compounding, and the Tyranny of Taxes


Today I want to talk about something that is often ignored, yet has a very large impact on the net performance of our trading and investing: Taxes. To illustrate the importance, I often like to point out both the power of compounding and the impact of taxes with a simple example.  

If you could double a dollar every year, for 20 years, how much do you think it would be worth? Before glancing down, I'd really encourage you to take a guess first...So for example, I'm saying:

 

$1

End of year 1. $2

End of year 2. $4

End of year 3. $8

 

And so on, for a total of 20 years...Now go ahead and stop, without cheating, and make your guess. Doing this with people for more than a decade now, I get answers that have a wide range, but are consistently below the actual result. And usually not even close. So here we go:

 

  $1
1 $2
2 $4
3 $8
4 $16
5 $32
6 $64
7 $128
8 $256
9 $512
10 $1,024
11 $2,048
12 $4,096
13 $8,192
14 $16,384
15 $32,768
16 $65,536
17 $131,072
18 $262,144
19 $524,288
20 $1,048,576

 

Is your mind blown? Don't feel bad if you guessed something that wasn't even in the thousands...there is a reason why Einstein referred to compound interest as the 8th wonder of the world! Now, obviously there isn't an investment that can sustain this kind of performance, it's just an example to drive a point, but even a $100/month investment at 12% annualized return can turn into more than $1,000,000 over 40 years. That means it's very realistic for a 25 year old entering the work force to retire as a millionaire at age 65, regardless of salary, based on historical stock market trend line performance. Time is our greatest asset. And taxes are our greatest liability...so let's keep this example moving along with that in mind.

 

If the example above were held in a tax free vehicle, such as a Roth IRA/401(k), Health Savings Account, or in certain situations a properly designed low fee cash value life insurance policy, the $1 million could potentially be yours to keep, income tax free. If the $1 million was protected by a tax-deferred vehicle such as a Traditional IRA/401(k) or a low fee variable annuity, the earnings could be tax deferred until withdrawn. This is also true to a large degree with certain tax managed equity mutual funds and ETF's that are able to avoid capital gain distributions.

 

But what if this example was exposed to income tax on the earnings every year at the current top Federal rate of 37%? Like before, guess what the ending value would be...So to be clear...

 

$1

End of year 1: $2 minus income tax (37% of $1 = $0.37)...$1.63

End of year 2: $1.63 * 2 = $3.26 minus income tax (37% of $1.63 = $0.6031)...$2.66

And so on, again for a total of 20 years...Make your guess now on the ending value.

 

  $1.00
1 $1.63
2 $2.66
3 $4.33
4 $7.06
5 $11.51
6 $18.76
7 $30.57
8 $49.83
9 $81.22
10 $132.40
11 $215.81
12 $351.76
13 $573.38
14 $934.60
15 $1,523.40
16 $2,483.14
17 $4,047.52
18 $6,597.46
19 $10,753.86
20 $17,528.80

 

Is your mind blown again? The bad news is that we can't really control what the financial markets do, but the good news is that we have a reasonable degree of control over protecting our investments from income taxes. It just requires we pay attention to the vehicles we put our money into, and the type of trades and strategies we execute in taxable accounts. Many traders and investors ignore the impact of taxes when considering a product or strategy, but it's simply unwise to do so if you're in a high tax bracket. It's not how much you make, but how much you keep, net of all fees and taxes.

That's especially true if you're also in a state with a high state income tax rate, such as CA or NY. Tax efficient vehicles, and tax efficient investment products and strategies are available to everyone today. As a CFP® professional, I can help my clients build long term financial plans and investment portfolios that align with both their unique willingness and need to take risk, as well as their unique tax situation. 

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse is managing the LC Diversified portfolio and forum, the LC Diversified Fund, as well as contributes to the Steady Condors newsletter.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Q&A with Mental Game Coach Jared Tendler

    QUESTION: Thank you for taking the time to participate in a Q & A session with Steady Option. Let’s start with an introduction and a little bit of background on who you are and how you got here.

    By Jared Tendler,

    • 0 comments
    • 150 views
  • Using TLT Options to Increase Expected Returns of a Buy & Hold Portfolio

    TLT is the iShares 20+ Year Treasury Bond ETF that seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. Even though US Treasuries typically act as a diversifying asset class to mainstream equities, many investors with long time horizons may not be interested in holding TLT in their portfolio because it would lower expected returns.

    By Jesse,

    • 0 comments
    • 120 views
  • Tax Efficient Trading Part II: Capital Gains Deferral

    In part I I illustrated how the preferential tax treatment of 1256 contracts could improve after tax returns of a PutWrite strategy over a long period of time. In this article, I’ll continue the illustration by switching from a PutWrite to an ETF BuyWrite (covered calls) strategy while holding pre-tax expected returns constant at 8%.

    By Jesse,

    • 0 comments
    • 668 views
  • Tax Efficient Trading Part I: The 1256 Contracts

    Cash settled index options like SPX, XSP, RUT and a few others receive special federal tax treatment where 60% of the gains are reported as a Long Term Capital Gain (LTCG) even if the contract was held for less than a year.

    By Jesse,

    • 0 comments
    • 613 views
  • SPY Short Puts vs. Put Spreads

    In this article I’ll be using the ORATS Wheel backtesting tool to compare the performance since 2007 of SPY short puts versus short put spreads. I’ll look at both risk and returns, and different ways of determining position size to adjust for the differences in risk between the two trades.

    By Jesse,

    • 1 comment
    • 1,275 views
  • Signs that you Are Ready to Start Investing

    If you want to build your wealth, you have to make sure that you invest your money. If you put money into a savings account and don’t earn any interest from it, this won’t work for you in the long term. Your money will lose value because of inflation, and this is the last thing that you need. So when do you invest?

    By Kim,

    • 0 comments
    • 783 views
  • One Year of Diversified leveraged Anchor

    I almost hate to keep saying it, but the Diversified Leveraged Anchor strategy keeps exceeding expectations and performing as designed. To remind our readers, Diversified Leveraged Anchor was created in April 2020 attempting to further increase performance, reduce risk, and to reduce volatility. 

    By cwelsh,

    • 5 comments
    • 1,745 views
  • Should I Pay Off My Mortgage Early Or Invest?

    Paying off a home mortgage early is a popular financial goal. Most people feel a level financial peace when their home is paid off that is beneficial in many ways. The most common approach to paying off the mortgage early is directly making additional principal payments to the lender on a regular basis.

    By Jesse,

    • 0 comments
    • 808 views
  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 17 comments
    • 2,367 views
  • What Trading Can Offer To A Newcomer

    For any first-time investor, one of the most important questions to ask is “why are you doing this?”. Getting into investment can be thrilling and open up new worlds for you, but it can also be draining both physically and emotionally, with long days and sudden market moves always a genuine risk.

    By Kim,

    • 0 comments
    • 999 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido