The Little Book of Main Street Money: 21 Simple Truths that Help Real People Make Real Money

Chapter 9. To Add Wealth, We Need to Overcome the Subtractions

If We Aren't Careful, We'll Double Our Money—in 47 Years

Getting it is one thing. Keeping it is another.

The financial markets can post astonishing one-year returns, such as the 30 percent-plus gains clocked by the Dow Jones Wilshire 5000 stock index in 1985, 1991, 1995, 1997, and 2003. Indeed, at times, Wall Street can seem like a magic money machine, minting millionaires on a daily basis.

But dig a little deeper and you find investors aren't faring nearly as well as the raw returns suggest. Why not? At issue here is the triple threat of investment costs, taxes, and inflation. If your portfolio isn't overcoming those big three subtractions, you aren't making any money.

Slipping Away

Imagine you hold a classic balanced portfolio, consisting of 60 percent stocks and 40 percent bonds. Before all subtractions, that mix delivers 8 percent a year, which is enough to double your money every nine years, thanks to investment compounding. But even if your investments earn an 8 percent raw return, you will pocket far less if you're careless about investment costs and taxes. For instance, you could easily lose two percentage points a year and possibly more to mutual fund expenses and other costs. That would turn your 8 percent return into 6 percent. If you're sloppy about taxes and you are in the 25 percent federal income tax bracket, that 6 percent may become 4.5 percent. Inflation might then steal another three percentage points, ...