It’s Time to Get Real

During times of market volatility, it can be easy for investors to lose sight of two seemingly immovable obstacles standing in the way of their long-term investment goals: taxes and inflation.

The tax bite of investment returns is most obvious around April 15. The immediate effect of taxes takes anywhere from 10% to 35% of your investment returns in one fell swoop.

The effect of inflation on investments can be harder to spot, but it may be just as threatening to your long-term return. Although inflation does not immediately affect your return in the same way that taxes do, it decreases the purchasing power of what’s left. In fact, in spite of deflation worries in October 2008, when the consumer price index experienced the biggest one-month drop in its 61-year history, inflation was still 3.7% higher than 12 months earlier.¹

To see the way in which taxes and inflation work in concert to reduce overall investment returns, an investor can determine the investment’s real rate of return. As you can see in the hypothetical example below, an investor in the 25% tax bracket would need more than a 5% gross rate of return just to break even. (This example does not consider any state income taxes.)

You can use the worksheet to estimate the effect that taxes and inflation might have on one of your own investments and to determine the investment’s real rate of return.

1) U.S. Bureau of Labor Statistics, 2008