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March 15, 2006

A dose of reality in investing

We often hear examples of tremendous gains in investment markets, like the stock market, over long periods of time. For example, it’s been said that $1,000 invested in the stock market in 1926 would be worth almost $2.7 million today, even given all the ups and downs the market has experienced. While such statements may be true, N.C. State University economist Mike Walden says they leave out two key considerations.

“First thing is they leave out inflation,” says Dr. Walden, a specialist with the North Carolina Cooperative Extension Service. “That $2.7 million is in terms of current dollars, and it’s not been adjusted for inflation.

“And, indeed, if you did adjust those dollars for inflation, [to] be comparable to what the $1,000 could buy back in 1926, that $2.7 million would actually be worth $46,000 -- you’ve still gained but not nearly as much.

“So it’s very, very important when you are looking at these long-run gains in investing, you have to account for inflation.

“You also have to account for taxes paid. That can take out anywhere from maybe 20 percent to as much as a third of your investment return.

“And so what I would argue to people is when they are looking at these kinds of comparisons or when they are working with an investment professional, they always need to keep inflation and taxes in mind.”

Posted by deeshore at March 15, 2006 08:00 AM