Grand Lakes March 2018

ASK YOUR NEIGHBORHOOD PLANNER
By Craig Narum CFP®, Grand Lakes resident
THE MATHEMATICS OF INVESTING (PART 3 OF 4)
In Part 1 and Part 2, we focused on rate of return:
Total Return = (Ending Balance [EB] - Beginning Balance [BB]) / Beginning
Balance [BB]
Compound Annualized Rate of Return = [(EB/BB)^(1/# of years)] – 1
72/Annual Rate of Return = Number of years it will take for your money
to double at a particular rate of return
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In calculating your return, you may also wish to take taxes and inflation
into account by calculating the “real” rate of return. To determine an
inflation-adjusted rate of return, you’ll need to assume or estimate
an inflation rate over the investment holding period. To look at your
investment performance on an after-tax basis, you’ll need to know your
federal income tax bracket and state tax rate.
Remember Taxes and Inflation. You should always take into consideration
the effects of taxes and inflation when constructing an investment
plan to meet your financial objectives. After all, even if Jane earns an
average 9.54% on her investments every year, her “real” rate of return
will be reduced by taxes and increases in the cost of living.
Depending on Jane’s situation and income tax bracket, as much as
39.6% of her 9.54% compound annual return could be paid in federal
taxes, leaving her with [9.54% x (1 - 0.396)] or 5.76%.
Then, Jane must figure in the effects of inflation on her earnings. For
example, assume inflation averaged 3% over the two years that Jane
invested her $10,000 and that she earned a 5.76% compound annual
return after taxes, but before inflation. Now, Jane must adjust her
after-tax return for the loss of purchasing power caused by inflation.
To determine an inflation-adjusted rate of return, use the following
formula:
Inflation-Adjusted Return = [(1+Rate of Return) / (1+Inflation Rate) - 1]
x 100
Jane’s inflation-adjusted, after-tax rate of return is [(1.0576) / (1.03) - 1]
x 100 or 2.68%. Keep in mind that we’ve assumed the highest federal
income tax bracket (which does not apply to every investor); however,
the example does show the impact that taxes and inflation can have
on your return.
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No Substitute for Understanding. A Certified Financial Planner (CFP) can
help you gauge your investments’ performance, so you don’t have to do
the calculations yourself. But it is still your responsibility to understand
what it all means. Without that knowledge, you could make potentially
unfavorable financial decisions. With a fundamental understanding of
the information presented above, you’ll be better able to realistically
judge your investments.
Next month in Part 4 … A final look at the mathematics of investing by
looking at bond yields.
STREET LIGHTS
If you happen to notice streetlights that may not be burning or the
pole is leaning, you can contact CenterPoint Energy directly at their
customer service department at 713-207-2222. The information you
will need prior to contacting them, is the actual pole number; a six-digit
number that is on a plate located on the pole itself and the address
nearest to that particular pole.
Community Newsletter | March 2018
7