Tax Efficient Savings in Luxembourg
By Michael Doyle
This article is published on: 6th November 2014
Two of the main concerns many of my clients have whilst living in Luxembourg are:
- The low interest rates they receive from saving in the bank.
- How can they save in a tax efficient way?
At the moment, as most of you will already know, whilst leaving your funds to accrue in a bank account in Luxembourg you can receive interest of around 1%. However, due to the European Savings Directive, you lose 10% of this as a tax, thus you will receive around 0.9% interest net.
Putting this in perspective, most of us have to save for the future, either for our pension provision or for our children’s further education. Based on the Liverpool Victoria Study in November 2007, it said that University costs increase at approximately 7.5% per annum (the current level of inflation for educational costs). This was further supported by an article in The Sunday Telegraph, (26th August 2007), which stated:
“School fees have risen 41% in the past 5 years”
Fees at many universities in the UK now stand at £9,000 per annum.
So the question we have to ask ourselves is whether or not by leaving our money in the bank, will we be able to meet all of our future goals?
One solution is to look at saving through a Life Assurance wrapper.
A wrapper is effectively an “investment platform” through which an enormous range of underlying investments can be purchased. Whilst the wrapper will be provided by a life assurance company, it is important to note that you are not paying a premium to purchase additional life assurance. It is, to all intents and purposes, an investment contract.
So what are the benefits of saving within a wrapper here in Luxembourg?
- All investments grow within the wrapper free of income tax and capital gains tax.
- As the wrapper is considered a life assurance contract it is not affected by the European Savings Directive.
- The premiums you pay could be tax deductible (subject to personal circumstances).
- You have access to investments perhaps only available to institutional investors.
- Lower minimum entry levels in underlying investments.
- Access to some of the top fund managers in the world.
- The flexibility to change your investment strategy at any time.
- The ability to access your funds if required.
- Higher bank rate. For example, there are currently bank rates offered within the wrappers of 4.25% per annum.
- Security.
Every person’s circumstances are different and you should always seek Independent Advice before making any investment decision. Here at The Spectrum IFA Group we offer a no obligation Financial Review before offering any advice.
Savings solutions in Spain
By John Hayward
This article is published on: 29th October 2014
Stockmarket falls and low interest rates
Have you seen your investments fall by over 4% in the last month? This could be the case if you have been invested in the stockmarket. Most people know that investments can go down as well as up. Over time, stocks and shares can make significant gains. However, it still hurts when one sees a loss of this amount in such a short period. Some people prefer to keep their money in cash but then we have another risk. Interest rates are low and, even with the suggested increases in 2015, they could remain low relative to inflation. What many people want, and probably need, is a steady increase in the value of their savings with as little risk as possible. So what is the solution?
The low risk solution
We at The Spectrum IFA Group have access to an insurance bond offered by arguably the largest insurance company in the UK and one of the largest in Europe. Their investment model has allowed consistent returns of over 4.5% a year (after deducting charges) whilst exposing the investor to a fraction of the risk of a stockmarket such as the FTSE100. Whilst the FTSE100 has fallen by more than 4% over the last month, this low risk approach has produced a gain of almost 1%.
Tax friendly in Spain and the UK
No tax is payable on the pure growth of the insurance bond. Even if withdrawals are made, the tax treatment is vastly more favourable when compared to bank accounts or other non-compliant arrangements (see an example of how tax is calculated here). If you are currently Spanish resident, but you subsequently move back to the UK, the bond can follow you and benefit from the advantageous tax treatment awarded to these policies in the UK.
Outside Spanish inheritance tax (IHT)
With Wills correctly drafted and you are deemed domicile the UK, this insurance bond is outside Spanish IHT because it is not based In Spain. With IHT in Spain extremely punitive for non-residents (law possibly to change in 2015), this is a huge benefit to the non-resident beneficiary. It can be written in joint names so as to avoid Spanish IHT on the resident owner.
No Modelo 720 declaration
As this bond is Spanish compliant, there is no obligation to declare it as an overseas asset on the Form 720. This is because the insurance company declares it to Spain each year.
To find out more about how we can help you arrange your savings in a more beneficial way, contact your local adviser or fill in the contact form below.
With care YOU prosper
By Spectrum IFA
This article is published on: 3rd October 2014
I’m getting an increasing number of calls from expats based here in France who are very worried and sometimes completely dismayed by the financial advice they have received elsewhere. Worried by the fact that their investments have decreased in value, and dismayed when they realise that they cannot even withdraw their money or cancel their polices, as parts of the investment are now in funds that have been suspended (that is no-one can either buy them or sell them).
Now I’m not looking to get into any legal wrangle with the company concerned, and it is only one company, but I think this is a suitable time to flag up what is happening in the hope that some of you will avoid falling into this situation in future. I will also add that I am prepared to ‘adopt’ clients in this situation, in order to ensure as fruitful an outcome for the client as possible.
What is happening is not illegal, but it could certainly be regarded as unethical. The clients concerned have either unwittingly or deliberately chosen to put their faith in an adviser who is not regulated in France. This is not illegal, because we are all part of the wonderful organisation that is Europe, and that frees Europeans to ply their trade in other countries within the Euro block. That freedom of trade is not, however, backed up by a freedom of regulation. If you live in France and have cause to complain about advice you have received, the French regulator will show no interest in your case if the adviser is not in his jurisdiction. You will be guided to seek help from the regulator in the country where the adviser is based, and hopefully regulated. Good luck.
There are two main problems that I am seeing at present. The first relates to the quality of funds in which the clients are invested. At The Spectrum IFA Group we have an investment team that spend many hours evaluating hundreds, if not thousands, of funds and produce a recommended list for clients to invest in. There are of course hundreds of thousands of funds available, and we can’t look at them all, so we do allow our clients to choose their own investments if they wish, thereby ignoring our recommendations. All we ask, in this instance, is that you sign a form to accept that the investment was your choice. There are many good funds out there, but there are also some bad ones. All of the (now) clients who have suffered in this way have been put into a single asset class which has had a disastrous time in the past eighteen months. Needless to say, none of the funds involved are on our recommended list.
The second issue centres on a specific type of investment called a structured note. These are often complex derivative products, and the type of note that I am now seeing regularly, certainly falls into that category. So much so, that the product notes that accompany the investment clearly state that this is only for seasoned professional investors, who are willing to accept the potential for serious loss of capital. None of the people I’m taking to fall into that category. The structured note is an interesting concept, and not all of them are overly complicated. You may have seen me write about such a note in the past, and you may have seen such a product at our seminars, offering an excellent 12 month fixed deposit rate alongside a five year deposit where the reward is linked to the performance of the stock exchange index. Not exactly ‘Janet and John’ stuff, but I like to think that I can explain it completely to my clients. And I don’t use it unless I’m completely sure that the client also understands it. I don’t understand the notes I’m seeing recently, and I’m sure the client doesn’t either.
So why sell them? Simply because the companies that make up these products factor in an element of commission to the brokerage that sells the note to the end user, the client. Now I don’t know how closely you look at small print when you read articles from me or Daphne, but if you look at the bottom of this article you will see reference to our client charter at spectrum-ifa.com/spectrum-ifa-client-charter
If you have read the charter, or are just about to do so, you will see or have seen this:
Some investment funds or products within an Insurance policy may generate an additional initial commission. If this is the case, we undertake to rebate this commission to you (in full) by way of increased allocation.
Strangely (not), none of the new clients I’m speaking to seem to have benefitted from this principle. It seems clear to me that funds are being pedalled for the advisers benefit, not the clients. This is a very dangerous practice.
I must stress that no laws have been broken here, and no fraud has taken place. I sell a simple structured note, but I pass on the commission. I even have clients who are invested in the struggling asset class that we have been talking about, but only by their own choice, and for many months now that has been contra to our advice.
Be safe – use locally produced goods, and that includes financial advice.
If you have any questions on this, or any other subject, please don’t hesitate to contact me.
Investments and investment risk
By Spectrum IFA
This article is published on: 16th September 2014
As I am writing this article, the hot topic of the moment is of course the Scottish Referendum on Independence. The polls are swinging from one direction to the other, but only by a small margin between the ‘yes’ and the ‘no’ camps. The final result will most likely be very close.
Even the Queen has uncharacteristically got a little involved in the politics, by expressing her hope to a well-wisher in Scotland that people will think very carefully about the future. Whatever the result of the referendum, it is clear that the United Kingdom will change.
What will happen to investment markets if Scotland votes yes? Well the wider world outside of Scotland seems to have woken up to what is actually happening in Scotland. Sterling has weakened amidst the uncertainty of the outcome, but beyond this, I am not bold enough to forecast any further effect on markets. Like any other investment risk, it needs to be managed.
On this subject, The Spectrum IFA Group has produced a Guide to Investment Risk. This has been written in plain, no nonsense, down-to-earth English and covers a range of assets classes and strategies. The individual articles included in the Guide can be found on our website at: spectrum-ifa.com/spectrums-guide-to-investment-risk/
Alternatively, if you would like to receive a full copy of this Guide, please contact me.
We are also taking bookings for our Autumn client seminar – “Le Tour de Finance – Bringing Experts to Expats”. Our industry experts will be presenting updates and outlooks on a broad range of subjects, including:
- Financial Markets
- Assurance Vie
- Pensions/QROPS
- Structured Investments
- French Tax issues
- Currency Exchange
Places for our seminars are limited and must be reserved, in advance. So if you would like to attend the event, please contact me as soon as possible. The date for the local seminar is
Friday, 10th October 2014 at the Domaine Gayda, 11300 Brugairolles.
Alternatively, if you are reading this further afield, you may be interested in attending one of our other events:
- Wednesday, 8th October – St Endréol, 83920, La Motte, the Var.
- Thursday, 9th October – Chateau La Coste, 13610, Le Puy-Sainte-Réparade.
For full details of all venues can be found on our website at spectrum-ifa.com/seminars
If you cannot attend one of our seminars and you would anyway like to have a confidential discussion about any aspect of financial and/or inheritance planning, please contact me either by e-mail at daphne.foulkes@spectrum-ifa.com or by telephone on 04 68 20 30 17.
The above outline is provided for information purposes only and does not constitute advice or a recommendation from The Spectrum IFA Group to take any particular action on the subject of investment of financial assets or on the mitigation of taxes.
The Spectrum IFA Group advisers do not charge any fees directly to clients for their time or for advice given, as can be seen from our Client Charter at spectrum-ifa.com/spectrum-ifa-client-charter
Buying property – the alternative options
By Peter Brooke
This article is published on: 10th September 2014
Having a real estate investment is often an excellent decision for any investor, but many don’t have the ability to own a complete house or apartment. They may not have enough capital to buy the property outright, fund a deposit or receive enough income to be able to afford a loan.
For crew, it also can be difficult to get a mortgage due to the offshore nature of their income, though it is possible in some countries. So what other options might there be for having invested capital in the various property markets around the world?
Collective Investment Schemes:
There are many mutual funds that invest into bricks and mortar. Most of these buy into commercial property in developed markets, such as the UK or Europe. They are managed by professional managers and diversify across several commercial sectors, such as office buildings, retail stores (split between “out-of-town” and “high street”) and industrial complexes. They also always hold a portion of the portfolio in cash and property equities, i.e., the quoted shares of building contractors and the like. The cash and shares are to maintain liquidity so funds are available to investors who need to make a withdrawal without selling huge office blocks. The legal structure of property funds is very important to watch. During the financial crisis, several offshore funds (domiciled in the likes of the BVI and Cayman Islands) suspended and have since begun to liquidate, losing many investors their money; some are still suspended. At the same time, there were no UK authorized property funds that suspended.
Fractional ownership:
Although this term has broadened in the last decade, it basically means owning parts of a property. It tends to be most popular in the residential sector and can cover the entire range of property, from distressed sales and repossessions to luxury property clubs. You’re the legal owner of a share in the property; therefore, your name will appear on the deed and you share in the property’s costs and profits and are legally liable. One unique system available is to own “bricks” of property. This is when a company buys real estate at a discount, renovates if necessary and then sells “bricks” for a proportional price. This system allows an investor to own many bricks in many different properties, thereby hugely diversifying their property exposure. Their share of the rent is paid to them (after any management costs), and they can sell their bricks on a specially designed marketplace. An example of a market maker in this sector would be ownbrix.com.
When buying real estate, it’s wise to understand all the legal and tax implications of owning it, as it’s physically located in a jurisdiction and liable to the taxes in that location. If in any doubt, get advice.
How to protect yourself in uncertain times
By Spectrum IFA
This article is published on: 15th August 2014
Wealthy individuals have a lot more in common than just their wealth. Ambition, skill, patience, consistency and a strategic game plan are all vital to ensure success. Keeping an eye on the end goal and never giving up have been key to reaching greater heights.
Only a minority of the population become extremely rich, as the likes of Warren Buffet, Richard Branson or Paul Getty, but this does not mean that we can’t enjoy a comfortable lifestyle with luxuries and freedom.
World stock market performances over the last 60 years reveal that the enduring trend is up and it is evident that any sharp downward movements often coincided with world calamities. Even with the peaks and valleys, stock market performance over time still yields inflation-beating returns for those who remain loyal.
Despite this, investors are concerned about the fluctuating Gold price and negative impact of the mining and metal strikes in South Africa and the developing Russian/Ukraine crisis which is already a cause for alarm – Russia is now talking of disallowing air travel over its skies to the East thus hampering tourism, the lifeblood for many of the Asian Tiger’s economies.
Hearing the words ‘hang in there’ is not enough reassurance for those trying to save for retirement or financial independence. This in turn affects investors who feel the pinch whether it be through investment of stocks directly through their own portfolio comprising retirement annuities, pension plans, QROPS, unit trusts or any other long term investment products which are exposed to the share market.
The critical questions is …
“How you manage your income and investments to shield against market volatility?”
Well, there are basically two main strategies that need to be developed in order to provide an effective buffer against economic turmoil.
The first is effective management of income and the second is a well-structured investment strategy.
Effective Money Management
It is little wonder that rising interest rates cause such widespread concern when so many people and businesses are exposed to excessive debt. If you take an average small- to medium-size business owner, they will probably have an overdraft, two car leases, a home mortgage and perhaps credit card debt. In anyone’s book, this results in a big chunk of money to repay before the school fees have been paid or the life policy has been covered.
The first step to minimising the effects in uncertain economic times is to reduce debt. If you don’t have excessive debt, the impact of rising interest rates on your pocket will be negligible and it’s worth bearing in mind that if you have cash reserves, the higher rate will benefit you greatly.
Well-structured investment strategy
The consensus amongst investment experts is to advise individuals to construct an investment portfolio in order to take advantage of long term trends. If the long term structure of an investment portfolio is healthy, short term storms can be weathered.
The first defence against any volatility in the markets is diversification. What this means, is that investors need to ensure that their investment portfolio is structured in such a way that they have investments in different asset classes such as cash, bonds, property and equities.
Uncertainty and volatility are intrinsic to investment markets. For this reason, investment should be viewed as simply a means to having enough money to live the lifestyle that you would like to live.
An investment portfolio should remain unchanged during times of volatility, unless the factors upon which the construction process was based have changed.
Investors should not change a long term game plan based on short term volatility. Attempting to time the market based on short term movements only increases portfolio risk.
The best way to protect yourself from market volatility is to first reduce your risk, which can be achieved by reducing debt. By doing this, you will have a lot less to worry about if inflation forces interest rates up.
The next step is to ensure that your investment strategy has a long term view and a financial planner will be your best resource when setting up a long term portfolio.
If you realise from the above the importance of seeking proper professional financial advice involving risk classification and correct diversification, why not give me a call in order to facilitate a meeting where we can do this.
As safe as money in the bank
By Spectrum IFA
This article is published on: 24th July 2014
More than a fifth of UK citizens think that the best long-term investment is putting their money in the bank. This is the rather discouraging result of a July survey by Bankrate.
One of its questions was, “For money you wouldn’t need for more than 5 years, which one of the following do you think would be the best way to invest your money?”
- 26% – cash
- 23% – real estate
- 16% – precious metals
- 14% – stock market
- 8% – bonds
That thumping sound you hear is me banging my head on my desk!!
I assume those who opted for cash did so because keeping money in the bank seemed to be the safest choice.
However, for long-term investing, that safety is an illusion. The best and safest place to put your nest egg for the future is not in the bank, but in a well-diversified portfolio with a variety of asset classes. And here’s why:
Savings accounts and CDs are safe places to store relatively small amounts of cash that you expect to need within the next few months. The funds are protected by insurance. You know exactly where your money is, and you can get your hands on it anytime you want.
This short-term safety does not make the bank a good place for the money you will need for retirement or for other needs five years or so into the future. It may seem like safe investing because the amount in your account never goes down. You’re always earning interest. Yet, over time, that interest isn’t enough to keep pace with inflation.
The purchasing power of your money decreases, which means you’re actually losing money. It just doesn’t feel like a loss because you don’t see the loss in its value.
In contrast, the stock market fluctuates. The media constantly reports that it is “up” or “down” as if those day-to-day numbers actually matter. This fosters a perception that investing in the stock market is risky.
Combine that with the scarcity of education about finances and economics, and it’s no wonder that so many people are actually afraid of the stock market and view investing almost as a form of gambling.
Wise long-term investing in the stock market is anything but gambling. Instead of trying to buy and sell a few stocks as their prices go up and down, wise investors neutralize the impact of market fluctuations by owning a vast assortment of assets.
This is accomplished with a two-part strategy.
The first is to invest in mutual funds rather than individual stocks.
The second component is asset class diversification. The mutual funds you invest in will comprise all of the asset classes in proportions or percentages falling in line with your appetite for risk (conservative, moderately conservative, moderate/balanced, fairly aggressive, high risk). Ideally, a diversified portfolio should include at least four asset classes.
By holding small amounts of a great many different companies and asset classes, you spread your risk so broadly that the inevitable fluctuations are small ripples rather than steep gains or losses. As some types of investments decline in value, other types will be gaining value. Over the long term, the entire portfolio grows.
In the long term, investing in this way is usually safer than money in the bank.
Perhaps you are holding too much capital in bank accounts and are beginning to realize you will see no “real growth” thereon. Why not give me a call to arrange a mutually convenient time for us to get together to investigate better ways of having your money grow for you? It does no harm in checking and, who knows, you may come away pleasantly surprised.
“With money in your pocket, you are wise, and you are handsome, and you sing well too.”
Jewish Proverb
The REAL effect of inflation
By Chris Webb
This article is published on: 23rd July 2014
On a day-to-day basis, inflation isn’t necessarily something you spend a lot of time thinking about. However, occasionally, you might find yourself asking – what exactly is inflation? And how does it affect me?.
Inflation is simply a sustained increase in the overall price for goods and services which is measured as an annual percentage increase.
As inflation rises, every pound or euro you own purchases a smaller percentage of these goods or services.
The real value of a pound or euro does not stay constant when there is inflation. When inflation goes up, there is a decline in the purchasing power of your money. For example, if the inflation rate is 2% annually, then theoretically a £100 item will cost £102 in a year’s time and £121.90 in 10 years time.
After inflation, your money can’t buy the same goods it could beforehand.
When inflation is at low levels it is easy to overlook the adverse effect it has on your capital and the income it produces. Regardless of how things look today, the likelihood is that the price of all the goods we buy and services we use will be higher in the future.
Inflation does not reduce the monetary value of your capital, a pound is still a pound and a euro is still a euro, but it reduces the “real” value. It erodes the spending power of your money, potentially affecting your standard of living.
The chart below details the effect of inflation over a 15 year period, 1998 to 2013. It is easy to see that leaving money exposed to inflation risk and not attempting to beat it and achieve higher growth is a no win situation.
Many clients will say that investing is a risk (see my alternative article to risk), and of course there is always an element of risk but leaving your money in a low rate bank account, open to inflation risk, is surely the riskiest option…….you can’t win !!!
If you had left your money open to the effects of inflation between 1998 and 2013 then it would have lost 35% of its purchasing power.
As statistics prove we are living longer now which means that we can look forward to a longer retirement period therefore the impact that inflation will have on your finances needs to become a prime consideration.
Buying property in the UK
By Peter Brooke
This article is published on: 21st July 2014
Many crew like the idea of investing in UK residential real estate, not just Brits. The strong legal system, common language, lending availability (although this has changed somewhat) and large population, make property ownership in the UK an attractive option for growth and income investors alike.
The obvious risks are currency, liquidity and “arms-length management.” If you don’t earn in sterling, then owning a large sterling asset can mean large swings in value due to exchange rate changes. Annual liabilities can change dramatically too, so consider this.
Like property everywhere, it’s a highly illiquid investment. If you want to sell quickly, you may lose a lot of value, and it may still take months to get your money out. Although it’s an excellent part of a portfolio, property needs to be just that and not the entire dossier.
Managing a property (or portfolio of them) in the UK when you are based on a yacht in the Med or Caribbean can be very difficult unless you employ a good agent to manage any works or changes in tenants. This cost needs to be built into the figures as to whether or not to buy.
Having said that, if the rental yield is good (and therefore someone else is going to pay off your mortgage or give you a good income), then UK property can be an excellent choice, especially if you know the market. Big student towns still seem to offer excellent yield opportunities, but management costs tend to be high. The UK market is steady in terms of growth potential, but the Southeast and London are described as a “bubble” risk.
Buying property in the UK:
Be aware of the different types of ownership (freehold and leasehold) when researching property; they can have far-reaching consequences and costs. There will be Stamp Duty Land Tax (SDLT) to pay on the purchase, which is on a sliding scale from zero to seven percent for properties more than £2 million. Be aware of the brackets, as a slightly lower offer could save you thousands in stamp duty. On top of this, you will pay some legal fees for conveyance advice and services.
Borrowing in the UK:
It’s still possible for yacht crew to borrow, but it’s getting a little harder as banks tighten their rules, and the UK government may further legislation to tighten this more. Banks prefer that the property be rented out, as the income can help secure the loan. Interest rates for non-residents, especially yacht crew, also tend to be higher than those for residents. Generally, crew can borrow around 75 percent of the purchase price, and will have to fund the SDLT and legal fees as well. Any rental profit is taxable in the UK, whether you are resident or not, as is capital gains tax and inheritance tax.
There are many considerations when buying property, so good, qualified advice should be sought, especially if it’s part of an overall plan; a mortgage broker should also be able to find the best terms for you.
An Inflationary Tale
By Spectrum IFA
This article is published on: 20th July 2014
An Inflationary Tale
Inflation is a complicated concept. It’s not easy to understand but if ignored, your money will slowly and stealthily reduce. As a teenager growing up in the 70’s I would hear the newscasters talk about inflation and price controls yet could never tell if it was a good or bad thing. Interest rates were going up as were house prices and income. This had to be a good thing I thought but little did I know!. What I learned later in life as I studied inflation is that, like most things, inflation is a double-edged sword. There are winners and there are losers. It is good for some and bad for others. As you read this tale focus on the two main concepts about inflation. Learn what it is and what it means to an investment portfolio.
What Does The Word Inflation Actually Mean?
Type the word “inflation” into a search engine on your computer and you will probably get information informing you that inflation is “A rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects an erosion of the buying power of your money – a loss of real value. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.” If you are like me and read the above definition you are thinking blah, blah, blah, blah, blah. So since the objective of this Newsletter is to keep things simple, let’s just translate this to what it means to you as an investor.
I like to think of inflation in terms of what $100 can buy in the future if I don’t invest it today. Let’s say, for example, if I make 0% rate of return on my $100 bill because I either put it under my mattress or buried it in the ground or kept it in a safety deposit box and then a few years later I want to know what it can buy. This is what inflation means to the investor or consumer. What that $100 can buy is called purchasing power and purchasing power is directly proportional to the rate of inflation. The following table shows what $100 un-invested can buy at different inflation rates over different time periods. I call it my “Mattress Investing table” because it teaches us that you can’t put money under your mattress unless you want to guarantee that you will slowly erode the value of your money.
Mattress Investing
(The Loss of Purchasing Power Associated with Not Investing $100.00)
| Inflation Rate | 5 years | 10 years | 15 years | 20 years | 25 years | 30 years |
| 0% | $100 | $100 | $100 | $100 | $100 | $100 |
| 1% | $95.10 | $90.44 | $86.01 | $81.79 | $77.78 | $73.97 |
| 2% | $90.39 | $81.71 | $73.86 | $66.76 | $60.35 | $54.55 |
| 3% | $85.87 | $73.74 | $63.33 | $54.38 | $46.70 | $40.10 |
| 4% | $81.54 | $66.48 | $54.21 | $44.20 | $36.04 | $29.39 |
| 5% | $77.38 | $59.87 | $46.33 | $35.85 | $27.74 | $21.46 |
| 6% | $73.39 | $53.86 | $39.53 | $29.01 | $21.29 | $15.63 |
| 7% | $69.57 | $48.40 | $33.67 | $23.42 | $16.30 | $11.34 |
| 8% | $65.91 | $43.44 | $28.63 | $18.87 | $12.44 | $8.20 |
| 9% | $62.40 | $38.94 | $24.30 | $15.16 | $9.46 | $5.91 |
| 10% | $59.05 | $34.87 | $20.59 | $12.16 | $7.18 | $4.24 |
How should an investor read this table?
Investors should understand that if they keep money in a mattress for 15 years and the inflation rate over 15 years is 5% per year their $100 can only buy $46.33 worth of “Stuff” 15 years later. If inflation were to average 7% for 30 years their $100 could only buy $11.34 worth of “Stuff.” I know it’s silly to think that anyone would keep their money in a mattress but the reason I use the table above is because it illustrates the important concept about inflation which is loss of purchasing power. Inflation in and of itself is meaningless. What matters to people is what inflation causes which is the loss of purchasing power. As an example, when I get in my car to drive I have a rudimentary notion of how the engine functions. People that know me know I’m not mechanically inclined. I do however know how the steering wheel works. To an investor, inflation is the engine while purchasing power is the steering wheel. You can be completely oblivious to how an engine works and still be an excellent driver. So, if you are so inclined you can spend a disproportionate amount of time studying how the engine works or the nuances of inflation or you can learn how to drive and invest your money to combat the loss of purchasing power. How to invest your money to combat inflation is discussed in A Preservation Tale. I’ll give you a little hint—I am not a Gold Bug but if you put a $100 gold coin under your mattress instead of a $100 bill you have a much better chance of preserving purchasing power during inflationary times.
So once again, how should an investor read the Mattress Investing table?
Let’s focus on the 3% inflation rate since that has been a good approximation for so many decades. What this table shows is that if the inflation rate is 3% and you keep your $100 under your mattress, in 5 years it will only buy $85.87 worth of “Stuff.” I like to use the technical term “Stuff” to describe purchasing power!. To investors, the intended use of a $100 bill is to be able to buy “Stuff.” In and of itself the $100 bill is worthless. Its only value is the amount of “Stuff” it can buy. In this case it can only buy $85.87 worth of “Stuff” so the Mattress Investor has lost $14.13 of “Stuff” by keeping it in his mattress or not investing it. When you hear the term Loss of Purchasing Power it means “Stuff” you can’t buy!.
This leads directly to what I consider the minimum objective for investors and one of my maxims.
The purpose of investing should be to at a minimum maintain your purchasing power. I believe you should invest so that you don’t lose your “Stuff.”
Learn
So what can we learn from this tale that puts money in our pocket? Who wins and who loses from inflation? By now it should be clear that at any inflation rate greater than 0% you must make more than 0% on your money in order to maintain purchasing power. Yet when guaranteed interest rates are not accommodative, like they are today and have often been in the past, the investor must invest in non-guaranteed investments to maintain purchasing power. For investors that have read tales such as this one this presents a quandary. They can intelligently ask themselves, if I want a guarantee and guaranteed rates are so low that I can’t preserve purchasing power then I must accept a loss of purchasing power. However, if I want an opportunity to maintain purchasing power I must assume risk. This is the never-ending portfolio management question that is forever on every investor’s mind and will be at every stage of their life. While most investors answer this question by forgoing guaranteed returns in order to not just maintain purchasing power but to potentially increase purchasing power, others do not. There are investors that choose to avoid risk at all cost and are knowingly watching their purchasing power slowly erode.
Unfortunately, the sad circumstance for most risk-averse investors is that they behave as they do out of ignorance or fear and not based on knowledge. Many are willing to invest their money in bank CDs, money market funds and government bonds at below required levels just to keep it guaranteed. The only guarantee they’re getting during most periods is the guarantee of a loss in purchasing power. When and if there is increased inflation these are the people that will also suffer the most.
Warren Buffet
Lastly, I have included a paragraph from a 1977 article written by Warren Buffett for Fortune Magazine on inflation. Inflation was a big deal back then though we tend to dismiss it today since it’s been so low for so long. But I thought the paragraph would be appropriate since it is easy-to-understand writing and he has a unique way of thinking about inflation as a tax. If you think of it the same way you will quickly understand that inflation is a consumer of your capital. We as a society take to the streets if there is so much as a hint of our elected officials raising our taxes. Yet we have no problem when we willingly or out of ignorance tax ourselves by investing in below inflation rate guaranteed investments. The following is taken straight from the article.
“What widows don’t notice”
By Warren Buffet
The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5 percent inflation. Either way, she is “taxed” in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120 percent income tax, but doesn’t seem to notice that 6 percent inflation is the economic equivalent.
If you are concerned that your money is not achieving returns equal to or higher than the inflation rate or wish to review your portfolio so as to make sure it is geared to do so, then please do not hesitate to give me a call.