Same average return.
Half the money.
Two funds, both averaging 12 per cent a year. One rides a calm path, one a wild one. The average looks identical on the brochure. What compounds is the geometric return, and the wild ride pays a tax on every swing.
| Two funds, same 12 pct average |
Calm fund |
Wild fund |
| Yearly swings, vol | 8 pct | 30 pct |
| What actually compounds, CAGR | 11.68 pct | 7.50 pct |
| Volatility tax per year | 0.32 pct | 4.50 pct |
| Rs 10L grows to, 20 years | Rs 91.1L | Rs 42.5L |
The tax has a formula. It is roughly the volatility squared, divided by two. At 8 pct swings it shaves about a third of a point. At 30 pct it eats 4.5 points a year. Same headline average, and over twenty years on Rs 10L the calm fund ends near Rs 91L while the wild one limps in around Rs 42L. The gap is not skill. It is the swings.