The Taxable Investor's Manifesto

CHAPTER FOURIf You Want Wealth to Grow, Own Stocks

The power of compounding may feel as amorphous as deferring tax, but it is even more powerful. The two concepts are also inextricably linked for taxable investors. Growing $1,000 at a 4% rate from age 20 to age 70 years generates $7,107. If the growth rate is 8%, one ends up with $46,902. 8% instead of 4% doesn't double one's assets over 50 years, it multiplies them by 6.6 times. Long-term after-tax rates of return matter, enormously. That is why this chapter is so important.

Once you've started building a base of diversified financial assets, the easiest and highest-probability way to generate a solid after-tax growth rate is to buy and hold a basket of stocks for decades. The easiest and highest probability way to build a top-performing equity portfolio is for that basket to track a broad market index. Indexing is neither a new nor a controversial concept. Many of the most experienced investors, from Warren Buffett to David Swensen to the late Jack Bogle, advise all but the most sophisticated investors to index their publicly traded equities. I agree, and the evidence broadly supports the advice.¹ It is very difficult, even for trained professionals, to determine in advance which of the thousands of stocks to choose among will grow faster than average and which will fall short. Plus, in the quest for better returns, every time you sell a stock to buy another one, you generate tax impact. Buying a broad market index obviates ...