Phipps Lane

Or — How to turn $173,000 into only $61,679 “safely”

Have you heard this “joke:” How do you make a small fortune? Start out with a large one. Long-term investors – that’s most of us — usually start out wanting a high rate of return combined with low risk or volatility. If only that were possible. You don’t have to become a casualty of financial malpractice. That fantasy is just what drove the recent Ponzi scandals.

Human nature also dictates that investors would like a high degree of certainty about the performance of their investments in the long-term. That is, most would like consistency. Like the old salesman said, “you can have any two of the following three: cheap; fast; good — but only two of them. Which two do you want?”

You can have high, reliable and predictable returns.
But not consistently; nor with certainty.

Perhaps a good perspective on the COST of consistency (or certainty) is to examine what is arguably the most certain and safe investment of all time — a 30-year U.S. Treasury Bond. Throughout the history of investing, the 30-year US Treasury Bonds may be the safest and most certain investment ever crafted by mankind.

Let’s assume that a conservative investor committed $100,000 to a 30-year Treasury Bond; currently, the investor would realize a yield of about 3.75% annually. After appropriate allowances for a 35% tax rate and a 3.5% inflation rate, the net return in real dollars to our investor typically and consistently would be negative 1% per year.

How does that happen?

Not only did your nominal after tax return of $73,170 actually only have a purchase value of $26,069 over the years, but also the $39,415 in actual taxes paid has the opposite effect of costing $67,884. And the initial $100,000, though returned in total, now only has the purchase power of $35,628.

So although the nominal effect is a total return of $173,000; but, the effective TOTAL RETURN (after adding the $35,628 and the $26,069) now acts and feels like ONLY $61,679. Hence, you would have achieved an awful reverse alchemy.

Yes, that’s right. A loss of over $38,000.

How is that for safety and certainty? The unfortunate reality is that the taxes are paid currently, and the inflation is compounded: a double whammy.

Therefore, our investors will get virtually no real return; however, he/she could take great comfort in the “certainty” that the initial investment amount will be returned in 30 years.

This is the price of certainty.

Since it is impossible to obtain satisfactory, high long-term investment returns, with safety and certainty, our choices boil down to the following:

–First, we can opt for “certainty” as illustrated by the preceding example. How much of that certainty would you like? A false sense of security.

–The second alternative is to work with a true financial coach to invest to achieve the most efficient long-term rate of return, Healthy Returns, while controlling and reducing uncertainty and risk as much as possible. True peace of mind.