Archive for July, 2016

Retiring early despite inflation

Thursday, July 21st, 2016

Suppose I want to retire early with an income of $100,000 a year after federal tax. Because I’m retiring early, I want to live on my returns only, without touching the principal. In order to do that, my investments need to make $128K a year, as approximately $28K will go to tax. Divide $128K by the rate of return of an investment, and that is how much you need invested.

That would be the whole story were it not for inflation. I once heard Ron Paul say inflation is an underhanded tax, and I agree because it is hidden double tax. For example, if inflation is at 4% and an investment gives me 4%, I would be losing money because I still have to pay tax on the 4%; I would end up with 2% to 3%. Stating that numerically, an investment of $100 would be $104 after a year, but I am taxed on the $4 gain regardless of inflation. I end up with $102. That $102 can only buy 96% of what it could the prior year, so it’s the same purchasing power as $97.92. I would have been better off just spending the money.

The market as a means of retirement:
Officially, inflation is currently at 1%, but according to Shadow Stats it is 5% or 9% depending on what metric you use. Even believing the government’s metric, inflation was as high as 5.6% in July of 2008, with an average of 3.22% . It depends on your tax bracket, but an investment that returns less than 5% is probably losing you money after taxes and inflation. Even if you get a tax-exempt investment such as municipal bonds, you still have to subtract 3.22% to get your adjusted rate of return. VWAHX has a 5.43 10 year rate of return, subtracting 3.22% gives a inflation adjusted yield of 2.21%. Using this investment, I need $4,524,887 to hit my $100,000 yearly income goal. While one can invest in higher-yield returns, they carry more risk that those retiring do not want to be exposed to.

Home ownership as a means of retirement:
My prior house, which I am now renting out, returns rental income of about 4% after expenses. Because the house appreciates with and the rent prices are fundamentally based on real inflation, that 4% is exclusive of inflation. Since I am taxed on this income, I need to make $128K a year at 4%, which works out to $3,200,000 were I to try to live solely off rental income.

Higher-yield stocks and diversification
Despite home ownership being a better investment, in cities with a heavy tech industry there are signs of a housing bubble. Housing prices are about double what they should be for the incomes in those areas, driven by shadow demand from investors. With the last housing bubble “the S&P 500 declined 57% from its high in October 2007 of 1576 to its low in March 2009 of 676” according to

If true, the best thing to do now is to hold investments that are not affected by a housing or stock market bubble. Wait for the bubble to pop, then when prices are normal invest in VFINX . Portfolio managers will not recommend this stock because they cannot make a profit from it: you have to buy it directly from Vanguard. However, it is the best investment due to its low expense ratio and 10.80% return.

Using a long-term 10.80% rate of return, then subtracting 3.22% for inflation, yields an average real return of 7.58%. I need to invest $1,688,654 to retire in this case (actually it’s even better than that because capital gains is lower than income tax).

While VFINX is clearly the most obtainable choice, the best strategy is to diversify with a combination of a high-yield fund and property ownership. The high-yield fund is sensitive to inflation and won’t return consistently, but over the long run is a higher-yield investment. Home ownership is resistant to inflation and will be more consistent.