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Negative Real Returns

Here is a nice article written by Dimensional Fund Advisors:

Even when the inflation-adjusted return on Treasury bills is negative, a relatively common occurrence, bond investors may still achieve positive expected real returns by broadening their investment universe.  CLICK HERE TO READ MORE:

 

Negative Real Returns.pdf


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail This email address is being protected from spambots. You need JavaScript enabled to view it. .

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

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Investing Long Term? Don't Overlook the Inflation Factor!

A penny saved is a penny earned, right? Not necessarily. Thanks to inflation, over time that penny could be worth less than when it was first dropped into the piggy bank. That's why if you're investing -- especially for major goals years away, such as retirement -- you can't afford to ignore the corrosive effect rising prices can have on the value of your assets.

Inflation Under the Microscope

Just what is inflation, this ravenous beast that eats away at the value of every dollar you earn? It is essentially the increase in the price of any good or service. The most commonly referenced measure of that increase is the Consumer Price Index (CPI), which is based on a monthly survey by the U.S. Bureau of Labor Statistics. The CPI compares current and past prices of a sample "market basket" of goods from a variety of categories including housing, food, transportation, and apparel. The CPI does have shortcomings, according to economists -- it does not take taxes into account or consider that as the price of one product rises, consumers may react by purchasing a cheaper substitute (name brand vs. generic, for example). Nonetheless, it is widely considered a useful way to measure prices over time.

Inflation has been a very consistent fact of life in the U.S. economy. Dating back to 1945, the purchasing power of the dollar has declined in value every year but two -- 1949 and 1954. Still, inflation rates were generally considered moderate until the 1970s. The average annual rate from 1900 to 1970 was approximately 2.5%. From 1970 to 1990, however, the average rate increased to around 6%, hitting a high of 13.3% in 1979.1 Recently, rates have been closer to the 1% to 3% range; the inflation rate was only 0.73% in 2015.

What It Means to Your Wallet

In today's economy, it's easy to overlook inflation when preparing for your financial future. An inflation rate of 4% might not seem to be worth a second thought -- until you consider the impact it can have on the purchasing power of your money over the long term. For example, in just 20 years, 4% inflation annually would drive the value of a dollar down to $0.44.


Or look at it another way: If the price of a $1,000 refrigerator rises by 4% over 20 years, it will more than double to almost $2,200. A larger-ticket item, such as a $23,000 automobile, would soar to more than $50,000 given the same inflation rate and time period.

Inflation also works against your investments. When you calculate the return on an investment, you'll need to consider not just the interest rate you receive but also the real rate of return, which is determined by figuring in the effects of inflation. Your financial advisor can help you calculate your real rate of return.

Clearly, if you plan to achieve long-term financial goals, from college savings for your children to your own retirement, you'll need to create a portfolio of investments that will provide sufficient returns after factoring in the rate of inflation.

Investing to Beat Inflation

Bulletproofing your portfolio against the threat of inflation might begin with a review of the investments most likely to provide returns that outpace inflation.

Over the long run -- 10, 20, 30 years, or more -- stocks may provide the best potential for returns that exceed inflation. While past performance is no guarantee of future results, stocks have historically provided higher returns than other asset classes.

Consider these findings from a study of Standard & Poor's data: An analysis of holding periods between 1926 and December 31, 2015, found that the annualized return for a portfolio composed exclusively of stocks in Standard & Poor's Composite Index of 500 Stocks was 10.07% -- well above the average inflation rate of 2.91% for the same period. The annualized return for long-term government bonds, on the other hand, was only 5.64%.2

There are many ways to include stocks in your long-term plan in whatever proportion you decide is appropriate. You and your professional financial planner could create a diversified portfolio of shares from companies you select.3 Another option is a stock mutual fund, which offers the benefit of professional management. Stock mutual funds have demonstrated the same long-term growth potential as individual stocks.


A Balancing Act

Keep in mind that stocks do involve greater risk of short-term fluctuations than other asset classes. Unlike a bond, which guarantees a fixed return if you hold it until maturity, a stock can rise or fall in value based on daily events in the stock market, trends in the economy, or problems at the issuing company. But if you have a long investment time frame and are willing to hold your ground during short-term ups and downs, you may find that stocks offer the best chance to beat inflation.

The key is to consider your time frame, your anticipated income needs, and how much volatility you are willing to accept, and then construct a portfolio with the mix of stocks and other investments with which you are comfortable. For instance, if you have just embarked on your career and have 30 or 40 years until you plan to retire, a mix of 70% stocks and 30% bonds might be suitable.4 But even if you are approaching retirement, you may still need to maintain some growth-oriented investments as a hedge against inflation. After all, your retirement assets may need to last for 30 years or more, and inflation will continue to work against you throughout.

Take Steps to Tame Inflation

Whatever your investor profile -- from first-time investor to experienced retiree -- you need to keep inflation in your sights. Stocks may be your best weapon, and there are many ways to include them. Consult your financial planner to discuss your specific needs and options.
 
Source(s):

1.  U.S. Bureau of Labor Statistics.

2.  Wealth Management Systems Inc. Stocks are represented by the S&P 500 index. Bonds are represented by a composite of returns derived from yields on long-term government bonds, published by the Federal Reserve, and the Barclays Long-Term Government Bond index. Inflation is represented by the change in the Consumer Price Index.

3.  Diversification does not ensure against loss.

4.  These allocations are presented only as examples and are not intended as investment advice. Please consult a financial advisor if you have questions about these examples and how they relate to your own financial situation. The investor profile is hypothetical.


Required Attribution

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.

© 2016 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail This email address is being protected from spambots. You need JavaScript enabled to view it. .

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

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Worried About Inflation? Consider TIPS

Treasury Inflation-Protected Securities (TIPS) are bonds issued by the U.S. Treasury whose principal is adjusted by changes in the Consumer Price Index (CPI). With inflation (a rise in the CPI), the principal increases. With a deflation (a drop in the CPI), the principal decreases.

 

TIPS are considered a low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, while their interest rate remains fixed. Interest on TIPS is paid semiannually and is subject to federal taxes, but is exempt from state and local income taxes.

 

The relationship between TIPS and the CPI affects both the sum you are paid when your TIPS matures and the amount of interest that a TIPS pays you every six months. While TIPS pay interest at a fixed rate, because the rate is applied to the adjusted principal, interest payments can vary in amount from one period to the next. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases.

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