This calculation assumes, moreover, that the index fund realizes its long-term gains every year, which most don't. If the fund does not realize the majority of its long-term gains until the end of the 25-year period (or until the fund-holder sells the shares), the performance would be significantly better. If the fund-holder eventually sells the fund, she will have to pay long-term capital gains taxes on as-yet-untaxed gain, but she will have enjoyed the benefit of compounding in the meantime. The tax difference between realized and unrealized long-term gains can be viewed as an interest-free loan from the government. You will eventually be on the hook for taxes on unrealized gains (unless you die), but in the meantime, you will enjoy the benefit of still having the cash compound in your account.