How Taxes Eat Into Compounding (Tax Drag)

Tax Drag is the gap that arises, because of taxes, between the 'pre-tax return' and the 'after-tax return that actually stays in your pocket.' Receiving dividends incurs dividend income tax, receiving interest incurs interest income tax, and selling stocks at a gain incurs capital gains tax.

The key is that 'the money taken away disappears.' The ₩10,000 that went out as tax is not just a ₩10,000 loss—the seed of compounding that would have rolled and grown over years and decades disappears along with it.

So tax drag is similar in nature to a 'fee.' It's a hole that leaks a little each year, and the longer the investment, the larger the final gap this hole creates.

Compounding is a structure where 'money you've earned earns more money.' But if a little tax leaks out each year, the very principal you roll into the next year shrinks. Repeated every year, the gap grows like a snowball.

Andrew Ang's 2026 study 'Uncle Sam's Cut,' which analyzed the U.S. market over 100 years, estimated the average annual tax drag for an individual investing in a taxable account under current U.S. tax law at about 1.98 percentage points. The study noted there were periods when this value historically reached as high as 5.38 percentage points.

Does 1.98% seem small? The same study calculated that, for a $100,000 portfolio, this drag creates a final difference of about $700,000 over 30 years. It's the result of a little over 2% each year failing to compound.

In Korea, tax drag varies greatly depending on 'what you buy and where' (as of 2026).

① Capital gains on domestically listed stocks: for ordinary individuals, these are generally tax-exempt (capital gains tax applies only if you meet the 'large shareholder' criteria). Instead, a securities transaction tax applies when you sell.

② Dividend income tax: receiving domestic dividends withholds 15.4% (14% income tax + 1.4% local income tax). If your financial income exceeds ₩20 million a year, you may become subject to comprehensive taxation.

③ Capital gains on overseas stocks: for U.S. stocks and the like, up to ₩2.5 million a year is deductible, and 22% (20% national + 2% local income tax) applies to the excess. For example, if your net profit for the year is ₩10 million, then (₩10 million − ₩2.5 million) × 22% = ₩1.65 million in tax. Moreover, it isn't withheld automatically, so you must report and pay it yourself the following May.

Tax drag is not something you eliminate through 'tax evasion,' but a concept you lower by adjusting 'when and how much you realize' within what the system permits.

Representatively, in tax-deferred accounts (pension savings, IRP, ISA, etc.), taxes aren't taken out immediately while the money rolls inside the account, so compounding is interrupted less. Also, the lower the frequency of buying and selling, the more the timing of realizing gains is delayed, tending to reduce the drag.

However, this is an area where the advantages and disadvantages completely change depending on an individual's income, assets, and plans. Here it's enough to remember only the principle that 'taxes are also a cost, a variable that determines the final outcome of long-term investing.' For specific tax planning, it's right to consult a tax professional.