Today’s investors face a broader range of decisions than ever before. Many take the planning path of least resistance, using the nominal returns of various asset classes to develop a back-of-the-napkin asset-allocation strategy. They then apply that improvised plan across all investment vehicles.
Focusing only on nominal returns ignores the degrading effects of inflation, taxes, and investment expenses. And using a single asset allocation plan disregards the potential benefits of different available vehicles. In this, the 20th edition of our Study of Real Real Returns, we discuss the three major factors beyond nominal returns that investors should use in successful planning.
The chart below illustrates the Thornburg concept of real real returns. We begin with the nominal returns of the S&P 500 Index, and account for the effects of inflation, taxes, and investment expenses, using real-world data for the past 30 years.
Three Factors that Impede Real Wealth Generation
Inflation: The Investor’s Nemesis
Inflation is the rate at which prices for goods and services rise. As prices rise, the purchasing power of a dollar — and the real return generated by an investment portfolio — falls. Inflation rates fluctuate fairly dramatically over time, even in developed economies. And reported vs. actual inflation rates are the subject of some
discussion. Recently reported rates have been benign, but many investors can remember years such as 1974 and 1980, when reported annual rates exceeded 12%.
Even without extraordinarily highinflation intervals, inflation has averaged just under 3% over the past 30 years. So an investment portfolio earning 6% nominally has its real return halved by the 3% rate. Investors in short-term instruments such as T-bills and money market funds have recently seen negative real returns, since near-zero nominal yields have been lower than the rate of inflation.
The U.S. Federal Reserve, the European Central Bank, and now the Bank of Japan have undertaken extraordinary monetary easing and bond purchasing programs designed to keep long-term interest rates low. Many are now concerned about the potential impact of that stimulus on global inflation rates.
See Full PDF here: A Study of Real Real Returns