Rate of Return (ROI) vs. Inflation

I set my goal back in 2010 that I would need $2 million to become a financially independent person. This means that I have enough capital to generate income which should cover my expenses.

I looked at the role of the inflation on my portfolio. Since the 2010 Cumulative inflation over 3 years is 9%.  In practical terms  it converts $100 in 2010 worth less than $92 today.  If current inflation rate will stay the same by 2040 the same $100 would worth only $48.

I reported that my portfolio worth $226,800 but in 2010 money it is $209,000. This underlines importance why  rate of return on your investments should be at least 2-3% above inflation rate.

Inflation adjusted rate of return on investments.

So far my portfolio has been very conservative, even now exposure to cash & precious  metals is 56%, before that it has been almost 75%. 

Large exposure to cash is still going to be inevitable, as my emergency fund is equal one year worth of expenses.  I will reduce it to 22% by 2016, by investing money into the stock market.

I was curious to find out, what sum  should I have if instead of investing into the stock market and keeping cash on the savings account I would bought TIPS (Treasure Inflation Protected Securities).

In July my nest egg networth  was $192,700 (£122,700) - the savings of $3,300 is subtracted.

I took inflation rates for each year and start adjusting my investments:

Inflation influence

Inflation. There is so many articles written about inflation, explaining benefits and downsides of it. 

What does it mean for an investor?  Part of the budgeting is  not only see how are you doing now and where the money goes to, but to have vision how to get from A to B.

Using my portfolio I will demonstrate clearly how does it mean an additional 10 (ten) years of work. The prospects and planning without taking inflation into account are rosy and glamour:

 

This means, that should I keep my contributions at $40 K a year, I will reach my target of financial Independence ($60 K a year from my investments at 3% interest) between 2033 and 2042, depending on the stock market performance.

My emergency fund and precious metals are not contributing towards growth - I use interest rate for the savings account at the inflation rate. It does not exactly right, but it simplifies.

This is a bit disappointing but let's have a look at the inflation adjusted scenario: