You have heard me say throughout my blogs, "It’s not about your return on principal but return of your principal and interest." Example question: If I can buy a gallon of milk today will my investments allow me to buy the same gallon of milk a month from now? I had a recent caller tell me, “my dad (who is not working with Sedway Financial) is proudly getting a 6% return on his money.” Within a few seconds of research I alerted him to the fact that his Dad had lost 25% of his principal. Ugh, right?
Two major types of Rates of Return: Normal rate of return and Real rate of return. One word makes a huge difference!
Quick calculation for real rate of return, using the simple formula of Nominal rate – Inflation rate. The Geek version: Real Rate of Return = 1+ normal rate/1+inflation rate-1 (there is a difference). Normal rate is the state rate or normal return that is not adjusted for inflation. Real rate of return is important because it is used to determine the effective return on an investment after adjusting for inflation (CPI/consumer price index). Interesting twist to think about, does your personal CPI match what is generally reported U.S. CPI? Educational and medical inflation is much greater then generally reported CPI. This is why financial planning is so very important to understand your personalized numbers, not just using guess work.
You think you are being safe? Easy calc. $UST10Y yield is 1.85 however the Real yield is 1.00% (Yield 1.85 - CPI .85) the challenge is the Federal Reserve target is 2% inflation so yield 1.85 – CPI 2.00 = -0.15. That is not keeping up with college tuition nor medical inflation...and probably not milk.
(Chart data is as of 4/21/2016)
I am awed by the U.S. M1 and M1 money supply. We hear daily how the rest of the world is also adding to the money supply. Physics dictates, "something has to give." (Also showing Consumer Price Index (CPI) and the US Dollar (USD).
I hope you see why Goals Based Planning and quality asset diversification should help you “Live a Good Life” and help you get return of your principal and interest.
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This is just for educational purposes, and I am not making any specific recommendations. This is simply a guide to assist you in thinking about your own personal position, how much risk you are willing to take, and what your expectations are.