Wealth Principles

I've recently reconsidered my perspective on target date retirement funds, also known as glidepath funds and typically found in 401(k) plans or other employer sponsored retirement plans.

Target date retirement funds gradually shift an investor's money into more bonds as they approach retirement. In a world where bonds maintain their purchasing power over time, this is considered an effective strategy. However, in today's world, I view it as a strategy that undermines purchasing power.

Similar to understanding your net pay after taxes to assess spending capabilities, the same logic applies to evaluating real returns in investing. Real returns account for gross returns minus inflation, the tax imposed on savers by government central banks to sustain the financial system.

For instance, an investor may see a 5% interest on $1,000,000 invested in a bond and think they earned $50,000. However, considering a 9% increase in the cost of living during the same period, the investor would have needed to earn $90,000 to maintain purchasing power.

As an investor, the goal is to send money into an uncertain future, aiming for increased purchasing power. This requires estimating returns and inflation to understand real returns.

While I won't delve into asset valuation methods today, the key is estimating growth over a period and discounting cash flows to the present using the US Treasury Bill rate.

Important to this discussion is understanding how I estimate inflation to grasp real returns. In the current financial system, money creation through debt causes the inflation rate to lag the debt growth rate. It’s not that clean cut and simple, but it’s a good rough estimation. 

Looking at the last 10 years of US debt growth (public and private) at around 12% annually, I anticipate a minimum inflation rate over the next decade. Subtracting these returns from gross return expectations yields real returns.

Here are my rough estimates for the gross and real expected compounded annual return of major asset classes:

Gross Returns:

• S&P 500 (Diversified American businesses): 10%

• 10 Year US Government Bonds: 4%

• US Real Estate (Single Family): 8%

• Bitcoin: 28%

• ARKW (our innovation proxy): 18%+

Real Returns (Net of Inflation):

• S&P 500: -2%

• 10 Year US Government Bonds: -8%

• US Real Estate: -4%

• Bitcoin: 16%

• ARKW (our innovation proxy): 6%+

Target date retirement funds lack the innovation asset class and typically don't include Bitcoin. Considering the automatic shift into lower real return assets over time, compounded with the system's high indebtedness which I assume will make inflation worse, poses challenges. Inflation and taxes play significant roles, impacting gains.

Investors who overlook these factors may find themselves with larger account values but diminished purchasing power a decade from now. Let me explain it in a simpler way.

Millennials, on average, earn higher salaries than their parents and grandparents did when they began their careers in nominal terms. However, when adjusted for inflation, they find themselves worse off because the cost of living has significantly increased, attributable to the higher level of debt in the system compared to when the parents and grandparents of millennials started their careers.

As an investor, it's important to focus on value, not just gross returns, as real returns measure value, which is always in motion.

P.S., If you are investing in a target date fund and want to have it reviewed, go to Stone Hill Wealth Management the foundational sponsor of this email newsletter and the wealth management firm I own. If you’re a client just email, call, or text me.

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