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Chapter 13. Taking the Long View > Real Rate of Return - Pg. 133

Taking the Long View 133 Figure 13.5. What is the real rate of return? Warning! An analysis of the real rate of return confirms our message from earlier chapters. Placing too much of your money in income and cash places you at the mercy of inflation. Investing long-term means you should avoid long-term risk. Safety-oriented investments work best when your goal is short-term. To understand real rate of return, answer this question: Who else wants your 401(k) money when you cash out? If you said Uncle Sam, you're right. Because your 401(k) or IRA money has been locked up inside a protective shell, the IRS has not been able to touch it. Because your 401(k) pre- tax contributions and all earnings are taxed at regular income tax rates, the net effect is that you are taxed on the total return, not the inflation-adjusted return. This doesn't make sense nor is it fair. After all, why should you have to pay taxes on something that does not increase your wealth? So how do our investments do after inflation and taxes? Assuming you are taxed at a 28 percent marginal tax rate, stocks produce the best inflation-adjusted, after- tax return of about 4.9 percent. The evenly mixed (diversified) portfolio produced a 2.1 percent return. Bonds barely broke even at 0.7 percent. And cash equivalents, a not-so-healthy ­0.4 percent.