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The Invisible Killer Of Your Investment Return

So what is the biggest threat to your investment portfolio? Well if your portfolio is structured with a majority percentage of your total assets in stocks you will most likely be thinking a stock market crash. If you have large holdings in bonds the answer would most likely be a huge decrease of the nation's money supply causing interest rates to climb to record highs. And if most of your money is in cash entities such as a savings account with your credit union you might feel that the financial collapse of that institution is the largest threat to your money. Well think again - the largest threat, and it really is not a threat because it is real and constantly present 24 hours a day 7 days a week, is in my opinion "INFLATION"!

Inflation is the invisible killer to the value of your investment, and just like rust on your automobile, it never sleeps. It is the dark invisible demon that not one financial institution ever talks about. You will never see it printed on any monthly or yearly statement you receive from your financial organization. And it is a lot larger factor than you most likely have ever imagined.

Most people during the last 20 years have completely forgotten the term "inflation" because the last decade the inflation rate has been running around an average of 3.1% a year. This is nothing when compared to the late 1970's and early 1980's when double digit inflation was the norm. So why should you have to worry about inflation? Well let's put it in perspective.

* At an average annual growth rate of 10.4% a year, stocks will double your money about every seven years. Factor in inflation, which has historically run at about 3.1% annually, and it will take more than 10 years to double your actual buying power.

* Likewise, bonds, which have historically grown at 5.4% annually, will double your money every 12.5 years. After inflation, however, it will take 26 years.

* If your money is in cash, you'll have to wait 23 years for the nominal value of your account to double, assuming the cash earns the historical 3.1% annual return. But even your grandchildren won't see the real value of your money double.

If the inflation rate is 3.5% the actual purchase value of your money is reduced almost in half every 12 years. This is actually amazing when you put it on a larger scale. I recently had a client contact me and inform me they had just sold their business for net earnings of $5,000,000 after all costs and taxes were paid. This client then began to inform me that a relative had placed the entire $5 M in a trust that was paying 4% so they would just live off the $200,000 a year interest payments. Well they then wanted my advice and here is what I presented them with. First they must pay taxes on the $200,000 which is 15% for capital gains so that is $30,000 right off the top (this does not include state and local taxes but we will just use 15% to keep it simple). So now you are left with $170,000 to live on right? Wrong, unless you don't care what your money is worth in 10 or 20 years. Because if inflation is not accounted for what your standard of living is on $200,000 today must be reduced to $100,000 12 years from now (if inflation does not increase above a 3.5% average). So then we say no problem lets just adjust for inflation and we will be fine right? Wrong again, at 3.5% inflation the value of the $5 M must be increased by $175,000 to hold the same purchase value at the end of the year. So now this client has to borrow $5000 to just break even. See the client must earn a return of 8.5% on the investment to generate a real value of just over $200,000 a year income. And the client must realize that they are now on a fixed income so inflation has even more weight to the equation.

Now I know that most of us do not have $5 M to live off but if we are to retire in a comfortable fashion it may not be so off from reality. So what ever you do when you are planning your financial future and how to get there make sure you adjust for inflation into the beginning, middle and final structure of your investment strategy. This will help insure that you meet these financial goals you set for yourself and family.

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