Money and Finance
Nominal returns are the total annual return that you received on the investment. Real return accounts for the effects of inflation.
Real Return = Nominal Return - Inflation Rate
For the purposes of this example I've assumed that $1 is invested at the beginning of 2012 and no additional investments are made for the rest of the study period. Since Warren Buffet knows a lot more about investing than I do, we'll use his 7% total return assumption. From 1914 to 2010 the average inflation rate was 3.38% so we'll go on and use that. There's a big difference in the dollar value at the end of 33 years.
The nominal return ends up turning $1 in to $9.33 of 2044 dollars. However the actual purchasing power that you have increased after accounting for inflation is only $3.23. The real return is only 35% of the nominal return. For that you can thank inflation This exercise goes to show that inflation is definitely something to take into account when planning your retirement saving.
Little changes in assumptions can make a huge difference in the final values. I've run the calculations for several different scenarios and the results are in the following table.
You can use the previous table to multiply your total investment balance by the real dollars column for whatever scenario you wish to get an approximation of your portfolio if you don't contribute anything else and let it be for 33 years. For example I currently have just under $80,000 across all my investment accounts. I'll take the 7% return with 3.38% inflation, the real dollar column shows $3.23. So $80,000 x $3.23 = $258,400. That's not bad but if you have followed this blog I'm looking for much better than that.
The scenario that I expect to play out is something in the area of the 7% nominal return with the 3% inflation rate. That would mean that every dollar that was invested at the beginning of 2012 would turn in to $3.65 of purchasing power. While inflation is a big concern in the long run, I believe that some effects of inflation can be accounted for through smarter purchases and getting your expenses to align with your true life goals. Of course so many variables go in to any projections that these are a rough guide. It's good to play around with the numbers to see what different scenarios would produce. We're all searching for the right balance between saving enough plus a little bit more for comfort so that we can enjoy our life as it goes. I hope that we can all find that balance.
- Hussman Weekly Market Comment: Cahm Viss Me Eef You Vahn To Live
Link to: Cahm Viss Me Eef You Vahn to Live “Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of good business conditions. The purchasers view the good current earnings...
- Hussman Weekly Market Comment: Did Monetary Policy Cause The Recovery?
As investors, we should be aware that the current Shiller P/E of 24.8 (S&P 500 divided by the 10-year average of inflation adjusted earnings) is now above every historical instance prior to the bubble period since the late-1990's, save for the...
- Hussman Weekly Market Comment: Inflation Myth And Reality
As for the stock market, it is desirable to believe that stocks will prove to be a good hedge against inflation, since they are after all a claim on nominal cash flows which grow over time as prices increase. This was certainly the expectation in the...
- Mutual Fund Vs Diy
The common belief is that you should just park your money in index mutual funds and annually rebalance. While I believe that's probably good for anyone that doesn't want to take the time to select their own investments, if you are so inclined...
- Selling Puts For Added Income
I've been looking around and have found some other potentially lucrative put option plays. All information is based off the closing values from February 10, 2012 and that the puts would be sold the morning of February 13, 2012. The current price for...
Money and Finance
Nominal vs Real Return
Nominal returns are the total annual return that you received on the investment. Real return accounts for the effects of inflation.
Real Return = Nominal Return - Inflation Rate
For the purposes of this example I've assumed that $1 is invested at the beginning of 2012 and no additional investments are made for the rest of the study period. Since Warren Buffet knows a lot more about investing than I do, we'll use his 7% total return assumption. From 1914 to 2010 the average inflation rate was 3.38% so we'll go on and use that. There's a big difference in the dollar value at the end of 33 years.
The nominal return ends up turning $1 in to $9.33 of 2044 dollars. However the actual purchasing power that you have increased after accounting for inflation is only $3.23. The real return is only 35% of the nominal return. For that you can thank inflation This exercise goes to show that inflation is definitely something to take into account when planning your retirement saving.
Little changes in assumptions can make a huge difference in the final values. I've run the calculations for several different scenarios and the results are in the following table.
| Nominal Return | Inflation Rate | Real Return | Nominal Dollars | Real Dollars |
|---|---|---|---|---|
| 4.00% | 3.38% | 0.62% | $3.65 | $1.23 |
| 4.00% | 3.00% | 1.00% | $3.65 | $1.39 |
| 4.00% | 2.50% | 1.50% | $3.65 | $1.63 |
| 7.00% | 3.38% | 3.62% | $9.33 | $3.23 |
| 7.00% | 3.00% | 4.00% | $9.33 | $3.65 |
| 7.00% | 2.50% | 4.50% | $9.33 | $4.27 |
| 10.00% | 3.38% | 6.62% | $23.23 | $8.29 |
| 10.00% | 3.00% | 7.00% | $23.23 | $9.33 |
| 10.00% | 2.50% | 7.50% | $23.23 | $10.88 |
You can use the previous table to multiply your total investment balance by the real dollars column for whatever scenario you wish to get an approximation of your portfolio if you don't contribute anything else and let it be for 33 years. For example I currently have just under $80,000 across all my investment accounts. I'll take the 7% return with 3.38% inflation, the real dollar column shows $3.23. So $80,000 x $3.23 = $258,400. That's not bad but if you have followed this blog I'm looking for much better than that.
The scenario that I expect to play out is something in the area of the 7% nominal return with the 3% inflation rate. That would mean that every dollar that was invested at the beginning of 2012 would turn in to $3.65 of purchasing power. While inflation is a big concern in the long run, I believe that some effects of inflation can be accounted for through smarter purchases and getting your expenses to align with your true life goals. Of course so many variables go in to any projections that these are a rough guide. It's good to play around with the numbers to see what different scenarios would produce. We're all searching for the right balance between saving enough plus a little bit more for comfort so that we can enjoy our life as it goes. I hope that we can all find that balance.
- Hussman Weekly Market Comment: Cahm Viss Me Eef You Vahn To Live
Link to: Cahm Viss Me Eef You Vahn to Live “Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of good business conditions. The purchasers view the good current earnings...
- Hussman Weekly Market Comment: Did Monetary Policy Cause The Recovery?
As investors, we should be aware that the current Shiller P/E of 24.8 (S&P 500 divided by the 10-year average of inflation adjusted earnings) is now above every historical instance prior to the bubble period since the late-1990's, save for the...
- Hussman Weekly Market Comment: Inflation Myth And Reality
As for the stock market, it is desirable to believe that stocks will prove to be a good hedge against inflation, since they are after all a claim on nominal cash flows which grow over time as prices increase. This was certainly the expectation in the...
- Mutual Fund Vs Diy
The common belief is that you should just park your money in index mutual funds and annually rebalance. While I believe that's probably good for anyone that doesn't want to take the time to select their own investments, if you are so inclined...
- Selling Puts For Added Income
I've been looking around and have found some other potentially lucrative put option plays. All information is based off the closing values from February 10, 2012 and that the puts would be sold the morning of February 13, 2012. The current price for...