Inflation is the #1 enemy for all investors. Taxes are the #2 enemy. Combined, inflation and taxes make a mighty opponent that makes it possible to loose even with positive investment return. To see why, lets analyze a hypothetical investor “Jack” who wants to buy a new car worth $25k. Jack has the money and he could buy the car immediately; however, Jack knows about the time value of money and decides to invest the money in stock market for 5 years before buying the car.

For the next 5 years, the inflation averages 4% and the stock market return is 4.5%. The price of the new car has risen to $25k*1.04⁵ = $30.4k. Jack is not worried first: His investment has risen to $31.2k. Unfortunately, Jack has to pay taxes for his investment gains. After taking out 15% for the long term capital gains, Jack is left with $29.9 which is not enough for a new car. The moral of the story is that investor should beat both the inflation AND taxes to come ahead.

Geek notes:

The minimum rate of return r to beat both inflation and taxes is given by

In our example, inflation is 4% and tax is 15% giving CAGR = 4.7%.