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Welcome to Radical Personal Finance, a show dedicated to providing you with the knowledge, 00:00:36.120 |
skills, insight, and encouragement you need to live a rich and meaningful life now while 00:00:40.440 |
building a plan for financial freedom in 10 years or less. 00:00:45.400 |
And today we're going to talk about the unbelievable impact of just a little bit of tax. 00:00:51.440 |
This is a redo of a show that I released earlier this week where I made a serious math mistake 00:00:58.000 |
If you haven't already listened to that show, go ahead and listen to this one. 00:01:00.680 |
You'll hear me correct the math mistake in just a moment. 00:01:03.360 |
But in the United States, we're just getting into what we usually consider to be tax season, 00:01:07.920 |
April 15th, the well-known day that your taxes are due. 00:01:11.920 |
And as we come into this last month here before taxes are due, I want to share with you a 00:01:16.280 |
series kind of a mini series of tax planning shows where we'll go over some specific ideas 00:01:23.920 |
And some of these ideas are going to be new ideas that I haven't really talked about in 00:01:30.000 |
Throughout the annals of Radical Personal Finance, you'll find lots and lots of shows 00:01:39.820 |
We've talked about businesses and business deductions. 00:01:42.480 |
But I want to present to you a couple of ideas that I haven't really discussed in detail 00:01:47.200 |
throughout the history of Radical Personal Finance in this series. 00:01:50.440 |
But today we begin not with a specific tax saving idea. 00:01:55.000 |
Today I want to simply share with you the incredible importance of actually saving money 00:02:01.760 |
Because a lot of people I think are too ambivalent when it comes to saving money on taxes. 00:02:05.760 |
Too many people look around and say, "Well, it's just a little bit of tax. 00:02:12.780 |
After all, taxes are the price we pay for living in a civilized society. 00:02:16.600 |
And I want to live in a civilized society, so I'm going to continue and pay my taxes." 00:02:20.760 |
But I want to demonstrate to you the importance of tax savings and show you why I think that 00:02:26.200 |
if you care about wealth, you should be very interested in or even semi-obsessed with the 00:02:37.200 |
I want to show you why this is so important so that you will go ahead and be interested 00:02:46.440 |
I want to begin today by talking about the story of the magic penny. 00:02:51.640 |
A friend comes to you and says, "Hey, listen, I'll give you two offers. 00:02:54.760 |
Offer number one is I'll give you a million dollars of cash today. 00:02:58.640 |
Offer number two is I'll give you a magic penny that will double in value every single 00:03:05.260 |
Now, of course, those who understand the power of compound interest on their investments 00:03:09.840 |
know that although we might not know the exact figure, we know we should choose the magic 00:03:14.040 |
penny because we know that with compounding, the magic penny will increase substantially 00:03:20.600 |
So let's go over the numbers here and remind you of how much it increases. 00:03:24.920 |
On day one, the magic penny is worth one cent. 00:03:27.960 |
And then of course on day two, it doubles from one cent to be two cents. 00:03:31.680 |
Day three, it doubles from two cents to four cents, then to eight cents, 16 cents, 32 cents, 00:03:37.960 |
So after one week, your magic penny has doubled to be worth 64 cents. 00:03:42.600 |
Well, it continues though, and then it starts to get more fun. 00:03:45.560 |
After two weeks, it's $81.92, but it's still doubling every day. 00:03:53.320 |
Four weeks in, you cross over that magic million dollar number, and you're at $1,342,000. 00:04:00.840 |
Then it gets really fun because in those last four days, it goes from 1.3 million to 2.6 00:04:09.520 |
And on day 31, you wind up with $10,737,418.24 in your account. 00:04:20.040 |
So if you choose the magic penny, you wind up being far better off than your friend who 00:04:25.160 |
chose the million dollars because of the power of compound interest. 00:04:32.880 |
And obviously the magic penny is a far better investment than we're going to find anywhere 00:04:38.160 |
I have no idea what you could possibly invest in that could double every single day for 00:04:44.320 |
But what I want to show you is the impact of just a little bit of tax on your long-term 00:04:48.800 |
investment values, even if you have such a stunningly amazing investment, such as the 00:04:57.960 |
Now let's talk for a moment about the actual amount of taxes that most of us pay. 00:05:02.120 |
The reality is that I think most people probably pay in excess of 50% of their income in taxes. 00:05:14.080 |
And the number actually changes depending on what level someone's earnings are. 00:05:19.200 |
So for example, if you're a very high income earner, if you earn millions of dollars of 00:05:23.240 |
wages per year in the United States, your overall tax rate will probably be something 00:05:29.000 |
like 40 or up to 50 and possibly in excess of 50%, depending on what state you live in. 00:05:34.200 |
You have a maximum marginal tax bracket of currently 37%. 00:05:39.080 |
You have some employment taxes, although when you have a high income, your employment taxes 00:05:43.780 |
are not a big factor in your overall taxation. 00:05:46.680 |
You have a little bit of miscellaneous Medicare tax. 00:05:48.920 |
You might have some state and local taxes, and then you have all the other taxes as well. 00:05:52.840 |
So you might be at 40 or 50% of your income in total income tax burden. 00:05:58.280 |
If you have a lower income, if you're lower on the income scale, then you're not going 00:06:03.360 |
to pay as high of a rate of federal income taxes or state income taxes. 00:06:07.800 |
But I still think there's a good chance that perhaps even 40 or 50% of your income is going 00:06:13.800 |
If you have somebody who makes say $100,000 a year, you'll have your 7.65% employee contribution 00:06:24.600 |
If you're self-employed, it'll be 15.3% of your income. 00:06:27.760 |
Then you'll have your federal income taxes on $100,000 income for a single individual 00:06:32.000 |
that might be 7, 10, $15,000, depending on deductions, retirement plan contributions, 00:06:39.560 |
So then you have your state and local taxes if applicable. 00:06:42.400 |
But then now your other taxes are a higher percentage of your income. 00:06:46.920 |
Things like property taxes, sales taxes, miscellaneous use taxes, gas taxes, sin taxes, the taxes 00:07:00.600 |
And so when you look at the totality of the taxes that you pay, it's a very high expense. 00:07:08.800 |
Now today, I just want to look at the impact of income taxes on this magic doubling penny 00:07:14.440 |
because it shows you how important it is for you to save on income taxes on your wages 00:07:22.760 |
Let's assume that we start with a very modest tax rate of 20%. 00:07:26.560 |
In the United States currently, you have capital gains tax rates, long-term capital gains tax 00:07:34.080 |
They might be zero if your income is low, or they might be as high as 20% if your income 00:07:40.580 |
So I'm using a 20% number for a good round number. 00:07:43.360 |
Now before we go through the numbers, I want you to predict to yourself. 00:07:46.540 |
Let's assume that every day as this magic penny doubles, you pay a 20% tax rate on the 00:07:55.080 |
How much would you have at the end of 31 days? 00:07:59.340 |
After seven days, of course, we wind up with not 64 cents, but we have 35 cents. 00:08:05.100 |
After 14 days, we wind up not with $81, but $23. 00:08:10.120 |
If we continue on after three weeks, we don't have $10,485, we have $1,571. 00:08:18.340 |
Now remember day 28 was the exciting day previously where we had $1.3 million. 00:08:33.220 |
On day 30, we have $343,000, and on day 31, we wind up with a grand total of $625,000 00:08:45.560 |
instead of the $10.7 million that we had previously. 00:08:49.000 |
We're down to $625,000, which is obviously a massive, massive change from what we had 00:09:02.280 |
You've gone from $10.7 million to only $625,000 by having your magic penny taxed only 20%. 00:09:12.860 |
Now let me tell you about the mistake that I made previously. 00:09:15.820 |
In the previous version of this show, I foolishly sat down about 15 minutes before I had friends 00:09:21.140 |
coming over to my house, and I said, "I'm going to get this show done. 00:09:26.140 |
I sat down and I did it really fast, but I messed up the math. 00:09:29.260 |
What I did in that show was instead of taxing only the gain, I taxed the entire portfolio 00:09:37.020 |
value, which is obviously not the way that taxes work currently. 00:09:46.780 |
What I did would in some ways be analogous to a wealth tax. 00:09:50.940 |
What I basically modeled in that previous error-filled show was what would you do if 00:09:57.620 |
you had an investment that doubled, and then at the end of the year, or in our case, at 00:10:02.460 |
the end of the day, the entire portfolio value was taxed at 10% or 20% or 35%. 00:10:11.020 |
When I went back and corrected the math, and thank you to the many listeners who pointed 00:10:14.220 |
out my error to me, it was just a dumb error, but they pointed out and showed me what I 00:10:19.300 |
When I went back and updated the spreadsheet and corrected the math, what's remarkable 00:10:22.620 |
is although the numbers are significantly higher than they were previously, the impact 00:10:29.780 |
With a 20% tax rate, you go from $10,737,000 to only $625,000. 00:10:38.340 |
Now what if we play with these numbers a little bit? 00:10:40.460 |
What if instead of a 20% tax rate, we just increase that to a 35% tax rate? 00:10:45.840 |
What if you do something like is being proposed in many countries around the world where instead 00:10:49.700 |
of capital gains taxes being taxed at preferential rates, what if capital gains taxes and income 00:10:55.380 |
taxes are unified and now you're paying 35% of your income on the gain? 00:11:03.260 |
Well now instead of $10,737,000, you wind up with a grand total of $94,000. 00:11:12.860 |
Your portfolio is completely and utterly devastated at 35% rates. 00:11:20.140 |
Now perhaps you say, "Well, Joshua, I don't live in a high tax country. 00:11:24.180 |
I live in a place where they have a fair flat tax, a measly 10%. 00:11:30.300 |
What does a 10% tax do on your daily doubling?" 00:11:33.860 |
Well remember previously, you had $10.7 million. 00:11:37.780 |
If you pay a 10% tax on that daily gain at the end of 31 days, you wind up with only 00:11:44.420 |
Now here's what I want you to pay attention to. 00:11:51.580 |
I want you to recognize how big the differences are with very slight changes in the rate. 00:12:02.460 |
The difference from 10% to 20% was millions of dollars. 00:12:08.460 |
The difference between 20% to 35% was virtually all of your gains. 00:12:15.940 |
So just a little bit of tax savings is a big, big deal. 00:12:19.240 |
Now let me be quick to point out obviously where this example may be falling short. 00:12:25.300 |
It may be falling short by simply demonstrating the fact that you're being taxed every year, 00:12:33.220 |
Your taxes would be much less if your magic penny was not taxed until you sold it. 00:12:38.300 |
And clearly that's how capital gains taxes work currently, at least in the United States. 00:12:45.860 |
You could leave it alone and it could double every single day until day 31. 00:12:50.820 |
And if at day 31, then you wanted to go out and sell the magic penny and go spend all 00:12:54.900 |
the money, that's when you would pay your taxes. 00:12:59.580 |
At a 35% tax rate, if you have $10.7 million, you would still clear six or $7 million. 00:13:08.260 |
I'm not ignorant of the fact that you can do that with capital gains taxes. 00:13:10.940 |
In fact, that's going to be one of the shows that we're going to do in this series. 00:13:13.460 |
I'm going to show you how to live tax-free with capital gains assets. 00:13:18.100 |
But what I want you to see is how when you're paying tax on a regular basis, you are devastating 00:13:26.700 |
Now you can avoid taxes on a lot of capital gains assets for a significant amount of time, 00:13:36.360 |
What you can't avoid taxes on every year is your wages. 00:13:41.380 |
And yet these same numbers are devastating the impact of your wages. 00:13:48.100 |
Let's say you make $100,000 and you make it tax-free. 00:13:51.540 |
Or you make $100,000 and you pay 20 or 30% of your income between employment taxes, income 00:13:57.860 |
taxes, and income taxes on the federal, state, and local level. 00:14:04.540 |
Now how much money do you have to save and invest? 00:14:08.120 |
And that dramatically impacts your overall investment returns. 00:14:13.940 |
Think about this lesson whenever you think about tax savings. 00:14:18.080 |
If you're going to build wealth, you need to decrease your expenses so that you can 00:14:22.760 |
increase the amount of money that you have to save and invest. 00:14:26.720 |
Expenses need to go down so that you can have more money to save and invest. 00:14:30.320 |
Because early on in your wealth building career, the single most important factor that drives 00:14:35.560 |
how wealthy you become is the amount of money that you invest. 00:14:40.400 |
That changes when you have a large portfolio. 00:14:42.360 |
When you have a big portfolio, then the single most important factor is your rate of return 00:14:48.920 |
But early in your life, the single biggest factor that drives how much wealth you build 00:14:53.920 |
is how much money you can save and invest every single year. 00:14:57.860 |
The guy who can save $100,000 a year is going to get far wealthier far faster than the guy 00:15:09.920 |
We talk about that extensively here at Radical Personal Finance. 00:15:12.320 |
The single best thing that you can do to improve your financial position is increase your income. 00:15:18.800 |
Because with a higher income, you can spend more money and enjoy the higher lifestyle 00:15:23.200 |
now while also being able to save more money and build more wealth long term. 00:15:30.200 |
So as your income gets high, you need to decrease your expenses. 00:15:33.800 |
When you look at decreasing your expenses, don't be a fool and go to the little daily 00:15:38.880 |
It's fine if you want to drink fewer lattes, that's fine. 00:15:42.040 |
It's fine if you want to cut back on your cable bill, if you want to cut back on your 00:15:47.520 |
But $14.95 a month of saving is not going to make that big of a difference if over here 00:15:54.440 |
you're paying $10,000, $15,000, $30,000, $500,000 a year of taxes. 00:16:00.360 |
So when you look at cutting your expenses, my advice is always go to the biggest factors. 00:16:05.600 |
Cut the big things first so that then you can have lots of money left over to save and 00:16:12.120 |
And the biggest thing for most of us is taxes. 00:16:18.840 |
I find it overwhelming, the number of taxes they want to impose. 00:16:22.380 |
And I find a lot of the planning really overwhelming because there's so many things that you can 00:16:27.780 |
But I want to encourage you that if you care about building wealth, there is no way to 00:16:33.560 |
There is simply no way to escape this formula. 00:16:36.780 |
You need to get your expenses low and you need to get that compound interest curve working 00:16:45.900 |
As we close, I want to just simply remind you that the first thing is simply that I'm 00:16:53.180 |
That sale is being done on all of my courses up through March 31. 00:16:59.220 |
If you go to RadicalPersonalFinance.com/store, you can purchase any of my courses, including 00:17:03.860 |
the course that I have there on how to increase your income substantially in the short term 00:17:09.420 |
and the long term by building a job or a business that you really love. 00:17:12.980 |
It's called the Radical Personal Finance Guide to Career and Income Planning. 00:17:16.900 |
You can find that at RadicalPersonalFinance.com/store. 00:17:19.380 |
On March 31, that course will disappear forever. 00:17:21.940 |
I'm taking it off the market, but if you buy it between now and March 31, I'll save you 00:17:27.860 |
50% by using the coupon code "Changing Platforms." 00:17:30.740 |
So just go to RadicalPersonalFinance.com/store and use the coupon code "Changing Platforms." 00:17:36.540 |
Now in addition to that, I was previously offering a discount on consulting. 00:17:42.060 |
That consulting work has now sold out, so that is no longer available. 00:17:45.920 |
If you would like to get in contact with me, what I would encourage you to do is to go 00:17:49.580 |
immediately and purchase one of those courses. 00:17:52.900 |
Because starting on Monday, I'm going to be doing a series of live Q&A calls, extensive 00:18:00.280 |
live Q&A calls with my students in those courses. 00:18:10.380 |
Sign up for any of those three courses there. 00:18:12.500 |
The coupon code "Changing Platforms" will save you 50% on whichever one appeals to you. 00:18:16.840 |
And I look forward to seeing you on one of those Q&A calls. 00:18:26.740 |
Escape the ordinary with Fiji Airways Global Beat the Rush Sale. 00:18:30.740 |
Immerse yourself in white sandy beaches or dive deep into coral reefs. 00:18:35.740 |
Fiji Airways has flights to Nadi starting at just $748 for light and just $798 for value. 00:18:42.820 |
Discover your tropical dreams at FijiAirways.com.