Beating Inflation

Beating inflation is critical to make savings last longer. The spreadsheet below tabulates how much money can be withdrawn (inflation adjusted) annually from a representative investment of $1000 at different levels of after-tax returns assuming an investment period of 60 years - 60-year investment period defines a family in the 40’s yearning for financial independence as early as possible:

After-tax Return Percentage	0	3	4	6	8	10	12
Withdrawal Amounts at 3% inflation	$6	$17	$22	$34	$49	$65	$81
Withdrawal Amounts at 5% inflation	$3	$9	$12	$22	$34	$48	$64
Withdrawal Amounts at 11% inflation	$0	$1	$1	$3	$7	$13	$21

The highlighted figures indicate that even at higher levels of inflation, 2% is a good withdrawal rate, provided the investment beats inflation on an after-tax basis by at-least one percentage point.

US Stocks have historically outpaced inflation by a much-wider margin over prolonged time frames. This out-performance is correlated to the actual GDP growth rate over the years and should continue moving forward conditional to US being able to grow its GDP. An alternative strategy is investing in a global basket of securities from a representative list of countries that are projected to grow their GDP in the upcoming years. Minor asset allocation adjustments every 5-10 years based on the countries expected to grow GDP highest is simple house keeping task. It is to be stressed that the consistent return associated with stock investments hold true only over extended periods of time.

A more cautious strategy that GUARANTEES moderate levels of inflation out-performance is the inflation-protected securities. In the US, the Treasury Inflation Protected Securities (TIPS) and series-I savings bonds are examples of such instruments. The caveats that need to be analyzed with such securities are:

• The inflation index such securities are pegged against. ie, if the index doesn’t accurately reflect the overall inflation rate, the guarantee of beating inflation may not provide the expected real return, and
• Tax implications – The tax effects for TIPS in the US makes it less desirable under certain situations. Specifically, the income from TIPS and the inflation adjustment are both taxable. The series-I savings bonds fare a little better in this regard as taxes are due only upon cashing them.