Why compounding isn’t always cool

June 12, 2019

Did you know tax liability plays a huge role in determining your net worth?

Just because an investment is making money doesn’t mean you get to bank it! You see, there’s this tricky thing called compounding. Here’s how it works.

  • Say you have $20,000 in an account paying 5% annual interest. At the end of year one, you have $21,000.
  • The next year, that 5% interest rate not only applies to your original principal, but also to the added interest from year one, boosting the account by $1,050 for a grand total of $22,050.
  • Keep compounding, and the number has the potential to grow like wildfire! In theory, this is how the world’s uber-wealthy make their fortunes.

The problem is, compounding can also work against you, especially when Uncle Sam comes to get his share. Any time you sell a property or liquidate a stock for a gain, the IRS takes their piece of the pie. But what if I told you there was a way to help keep your slice—and bake another pie?

Next time, we’ll discuss tax strategies.

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