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2021-03-11_774-The_Shocking_Truth_of_How_Just_a_Tiny_Bit_of_Tax_Destroys_the_Compounding_of_Your_Wealth_RE-DO_TO_CORRECT_A_SERIOUS_MATH_ERROR_


Whisper Transcript | Transcript Only Page

00:00:00.000 | Don't just dream about paradise, live it with Fiji Airways.
00:00:05.000 | Escape the ordinary with Fiji Airways Global Beat the Rush Sale.
00:00:09.120 | Immerse yourself in white sandy beaches or dive deep into coral reefs.
00:00:14.040 | Fiji Airways has flights to Nadi starting at just $748 for light and just $798 for value.
00:00:21.160 | Discover your tropical dreams at FijiAirways.com.
00:00:24.920 | That's FijiAirways.com.
00:00:26.640 | From here to happy.
00:00:28.160 | Flying direct with Fiji Airways.
00:00:29.960 | 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.
00:00:43.400 | My name is Josh Ruchites.
00:00:44.400 | I am your host.
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
00:00:57.000 | in that show.
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,
00:01:06.920 | right?
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
00:01:21.240 | to help you save on tax.
00:01:23.920 | And some of these ideas are going to be new ideas that I haven't really talked about in
00:01:27.760 | the history of Radical Personal Finance.
00:01:30.000 | Throughout the annals of Radical Personal Finance, you'll find lots and lots of shows
00:01:33.360 | on tax planning.
00:01:34.920 | We've done year-end tax planning.
00:01:36.400 | We've done big picture tax planning.
00:01:37.800 | We've talked about tax advantage accounts.
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
00:02:00.360 | on taxes.
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.
00:02:08.760 | It's only 15%.
00:02:09.760 | It's only 20%.
00:02:11.180 | It's not that big of a deal.
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
00:02:34.840 | topic of tax savings.
00:02:37.200 | I want to show you why this is so important so that you will go ahead and be interested
00:02:42.400 | in making good tax planning decisions.
00:02:46.440 | I want to begin today by talking about the story of the magic penny.
00:02:50.360 | You remember 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
00:03:02.680 | day for a month.
00:03:04.260 | Which one do you want?"
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
00:03:19.600 | in value.
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,
00:03:36.920 | and 64 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.
00:03:49.880 | Three weeks in, you're at $10,485.
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
00:04:05.840 | million, from 2.6 million to 5.3 million.
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.
00:04:29.520 | Now we know that.
00:04:30.760 | We know that that's powerful.
00:04:32.880 | And obviously the magic penny is a far better investment than we're going to find anywhere
00:04:37.040 | else in the world.
00:04:38.160 | I have no idea what you could possibly invest in that could double every single day for
00:04:43.320 | a month.
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
00:04:54.760 | magic penny.
00:04:56.200 | It's really, really substantial.
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.
00:05:10.120 | Now that's a number.
00:05:11.360 | I can't prove that to you.
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
00:06:12.640 | to taxes.
00:06:13.800 | If you have somebody who makes say $100,000 a year, you'll have your 7.65% employee contribution
00:06:21.440 | of your employment taxes.
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,
00:06:38.560 | et cetera.
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
00:06:56.400 | on alcohol, tobacco, et cetera.
00:06:58.760 | All of these taxes factor in.
00:07:00.600 | And so when you look at the totality of the taxes that you pay, it's a very high expense.
00:07:06.520 | It's a very high percentage of our income.
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
00:07:19.560 | and also on your investments.
00:07:21.320 | So let's look at the numbers.
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
00:07:31.120 | rates that are usually 15%.
00:07:34.080 | They might be zero if your income is low, or they might be as high as 20% if your income
00:07:38.720 | is high, but 15%.
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
00:07:52.840 | increase.
00:07:55.080 | How much would you have at the end of 31 days?
00:07:57.200 | Well, let's do the math.
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.
00:08:23.120 | Now we're down to $103,000.
00:08:27.560 | Then on day 30, we wind up with $188,000.
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
00:08:57.400 | previously.
00:08:58.760 | You've lost due to simply a 20% tax rate.
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.
00:09:23.580 | It's just going to be a 10-minute show.
00:09:24.740 | I know exactly what I want to say."
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.
00:09:44.660 | Why do I say 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%.
00:10:09.100 | That was obviously devastating.
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
00:10:18.300 | had done wrong.
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
00:10:27.100 | is still overwhelming.
00:10:28.100 | I mean, just look at that.
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
00:11:43.420 | $2,487,054.68.
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,
00:12:31.020 | or in our case, every day.
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.
00:12:43.780 | You could have this magic penny.
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.
00:12:58.580 | So you can do the numbers.
00:12:59.580 | At a 35% tax rate, if you have $10.7 million, you would still clear six or $7 million.
00:13:05.620 | So I'm not ignorant of that impact.
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
00:13:25.180 | your wealth.
00:13:26.700 | Now you can avoid taxes on a lot of capital gains assets for a significant amount of time,
00:13:33.500 | at least in a place like the United States.
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.
00:13:46.740 | You can run your own spreadsheets.
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.
00:14:01.900 | And then add your property taxes, etc.
00:14:04.540 | Now how much money do you have to save and invest?
00:14:06.980 | A lot less.
00:14:08.120 | And that dramatically impacts your overall investment returns.
00:14:12.260 | So that's the lesson.
00:14:13.940 | Think about this lesson whenever you think about tax savings.
00:14:17.080 | Think about it.
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
00:14:47.500 | on those investments.
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
00:15:03.340 | that can only save $20,000 per year.
00:15:06.560 | So how do you do that?
00:15:08.000 | Well, you increase your income.
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.
00:15:28.400 | So you focus on your income.
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
00:15:37.880 | stuff.
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
00:15:45.400 | Netflix bill, etc.
00:15:46.520 | That's fine.
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
00:16:11.120 | invest.
00:16:12.120 | And the biggest thing for most of us is taxes.
00:16:15.920 | I get really tired of tax planning.
00:16:17.840 | I really do.
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
00:16:25.940 | do and that you have to do.
00:16:27.780 | But I want to encourage you that if you care about building wealth, there is no way to
00:16:31.820 | escape this formula.
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
00:16:42.720 | on your side.
00:16:43.800 | So stay tuned for the rest of this series.
00:16:45.900 | As we close, I want to just simply remind you that the first thing is simply that I'm
00:16:51.700 | running a sale right now.
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.
00:18:03.700 | So you want to get in before Monday.
00:18:05.700 | That would be Monday, March 21.
00:18:07.700 | So go to RadicalPersonalFinance.com/store.
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.
00:18:22.420 | Don't just dream about paradise.
00:18:24.940 | Live it with Fiji Airways.
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.
00:18:46.620 | That's FijiAirways.com.
00:18:48.380 | From here to happy.
00:18:49.860 | Flying direct with Fiji Airways.
00:18:51.380 | (upbeat music)