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Chapter 13. Taking the Long View > Real Rate of Return - Pg. 132

Taking the Long View 132 Being in the market is important. But being in the market during the best months is even more important. The message for all our budding stock pickers out there: If you don't know for certain when the market has reached its peak or its bottom, just stay put. The worst thing that will happen is you will earn a little less than you would have had you timed the market correctly. Not much of a price to pay for peace of mind. Real Rate of Return Many investors are content with a 5, 6, or 7 percent average rate of return on their money over the long-term. That's okay as long as they have crunched the numbers to determine the corresponding savings rate for their expected investment return. As we have said earlier, there are many roads to a successful retirement. Eventually, there will come a time when you have to spend your 401(k) savings. The question is, how much will your money buy? To answer this question, we must look at something called "real rate of return." Ask yourself this question: If you averaged a 10 percent return on your money over a 75-year period, does the entire 10 percent go toward increasing your wealth? No. The reason why we do not get to keep and spend the full 10 percent return is that part of the investment return is needed to offset the effects of inflation. For example, if inflation averaged 4 percent and you earned 4 percent from your investments, are you ahead of the game? Answer: No. You're no better off than when you started. Your wealth is in the exact same place. In effect, your standard of living has stayed the same. As you can see from Figure 13.5, inflation averaged about 3.1 percent per year over the past 75 years. Inflation has a different impact on different types of investments. When we subtract this aver-