Camille Van Vyve
14 Feb 2024
Why regular profit taking is a not such a good idea
Some of you may be asking yourself this question: wouldn't I be better off regularly materializing my profit to “secure” the return in the long term? Quite intuitively, this strategy could be counterproductive in the broader perspective of building wealth and securing a stable financial future. Explanations and numerical example in this blog.
Importance of compound interest
One of the primary reasons to think twice before withdrawing profits annually is the magic of compounding. Compounding refers to the snowball effect where your earnings generate additional earnings over time. Withdrawing profits each year interrupts this compounding process, hindering the exponential growth potential of your investments.
Long-term vision vs. short-term gains
Successful investing requires a long-term perspective. Those who prioritize short-term gains through annual withdrawals may miss out on the compounding benefits that come with patiently letting investments grow over time. It's essential to weigh immediate financial gratification against the potential for much larger gains in the future.
Practical case
Let's imagine an initial investment of €100.000, invested with a constant annual return of 7%. After one year, this investment therefore generates €7.000 in return. There are two possible strategies: withdraw your profits each year, or reinvest them. With the first strategy, the profit is the same each year, accumulated in cash over time. With the second one, the profit amounts to €7.000 the first year and increase gradually, always housed within the portfolio. After 20 years, the shortfall from the first strategy compared to the second is…€147.000, which corresponds to a total profit 2 times lower.
| Year | Invested strategy #1 | Return | Cash | Total | Invested strategy #2 | Return | Total | Shortfall |
|---|---|---|---|---|---|---|---|---|
| 0 | 100.000 | 100.000 | 100.000 | 100.000 | - | |||
| 1 | 107.000 | 7.000 | 107.000 | 100.000 | 7000 | 107.000 | - | |
| 2 | 107.000 | 7.000 | 7.000 | 114.000 | 114.490 | 7.490 | 114.490 | -€490 |
| 3 | 107.000 | 7.000 | 14.000 | 121.000 | 122.504 | 8.014 | 122.504 | -€1.504 |
| 4 | 107.000 | 7.000 | 21.000 | 128.000 | 131.080 | 8.575 | 131.080 | -€3.080 |
| 5 | 107.000 | 7.000 | 28.000 | 135.000 | 140.255 | 9.176 | 140.255 | -€5.255 |
| 6 | 107.000 | 7.000 | 35.000 | 142.000 | 150.073 | 9.818 | 150.073 | -€8.073 |
| 7 | 107.000 | 7.000 | 42.000 | 149.000 | 160.578 | 10.505 | 160.578 | -€11.578 |
| 8 | 107.000 | 7.000 | 49.000 | 156.000 | 171.819 | 11.240 | 171.819 | -€15.819 |
| 9 | 107.000 | 7.000 | 56.000 | 163.000 | 183.846 | 12.027 | 183.846 | -€20.846 |
| 10 | 107.000 | 7.000 | 63.000 | 170.000 | 196.715 | 12.869 | 196.715 | -€26.715 |
| 20 | 107.000 | 7.000 | 133.000 | 240.000 | 386.968 | 20.665 | 386.968 | -€146.968 |
Tax implications
Beyond market dynamics, the tax implications of yearly withdrawals are worth considering. Frequent withdrawals may subject investors to higher taxes, eroding the overall returns on investments. In Belgium, the tax on stock exchange operations (TOB) amounts to 0,12% on each transaction. Capital gains made on shares are not taxed, and those made on bond funds are subject to withholding tax of 30%.
Take your profit to enjoy, not to accumulate
Despite the obvious advantages of interest capitalization, the objective of capital growth does not necessarily have to be pursued ad vitam aeternam. You have a project or need that requires financing? You want to improve your pension lifestyle? These are good reasons to take profits, either occasionally or in the form of an annuity. Conversely, withdrawing your profit in small installments and “as a precaution”, with the sole aim of keeping it in a savings account, is of little interest. As our example above shows, this strategy will not make you live more comfortably in the long run.
Easyvest advocates reinvesting profits
Reinvestment allows investors to take advantage of interest capitalization and achieve exponential capital growth. Many successful investors attribute their wealth to a disciplined approach of continually reinvesting their profits over the long term. Easyvest is a strong supporter of this approach and invests its clients' money only in capitalization funds. If necessary, or to guarantee regular retirement income, Easyvest will obviously advise you on the best withdrawal strategy to preserve your capital as much as possible. Either way, the first step to securing your financial future is simple: run a simulation on our website!