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Quote of the Day
“More investment sins are probably committed by otherwise quite intelligent people because of “tax considerations” than from any other cause….One of my friends—a noted West Coast philosopher—maintains that a majority of life’s errors are caused by forgetting what one is really trying to do.”
-Warren Buffett in his 1965 letter to partners
August 20th – This Day in Stock Market History
August 20th, 1982 – The Dow Jones Industrial Average closes the week by rising 30.72 points, or 3.66 percent. The move would cap off a week that saw the Dow rise more than 10% this week in 1982, while shattering volume records on the New York Stock Exchange.
The week would widely be viewed as the beginning of one of history’s most powerful bull markets.
August 20th, 1996 – The Small Business Job Protection Act of 1996 is enacted. The law created the Savings Incentive Match Plan for Employees Individual Retirement Account (more commonly known as a SIMPLE Plan or SIMPLE IRA), a contributory retirement plan for US small business employees.
The law also exempted a qualified State tuition program from taxation. These qualified tuition programs were to be called 529 plans, because 529 is the section of the Internal Revenue Code that governs their operation. These plans allow for individuals to save for qualified higher education expenses (and with the changes in 2018, certain secondary school expenses as well) on a tax free basis.
Best August 20th in Dow Jones Industrial Average History
1982 – Up 3.66%, 30.72 points.
Worst August 20th in Dow Jones Industrial Average History
1919 – Down 2.11%, 2.12 points.
Read of the Day
Taxes have a huge impact in long term investing returns. However, Buffett is right in that taxes are just one component to high long term returns. Ultimately, higher taxes is better if it means higher total returns.
Buffett’s thoughts on the topic changed as Berkshire grew. In his 1989 letter to Berkshire Shareholders, Buffett said:
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 yearend 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.
We have not, we should stress, adopted our strategy favoring long-term investment commitments because of these mathematics. Indeed, it is possible we could earn greater after- tax returns by moving rather frequently from one investment to another.
Many years ago, that’s exactly what Charlie and I did. Now we would rather stay put, even if that means slightly lower returns. Our reason is simple: We have found splendid business relationships to be so rare and so enjoyable that we want to retain all we develop. This decision is particularly easy for us because we feel that these relationships will produce good – though perhaps not optimal – financial results. Considering that, we think it makes little sense for us to give up time with people we know to be interesting and admirable for time with others we do not know and who are likely to have human qualities far closer to average. That would be akin to marrying for money – a mistake under most circumstances, insanity if one is already rich.
Also worth including here since we are on the topic of Buffett and taxes. Here is Buffett’s 1944 tax return, as a 14 year old:
According to the 1944 return, Buffett paid $7 in taxes on $592.50 of income in 1944.:
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