What is the break-even point before you get a real return?
Consider an investment that returns 5% nominally, that is, the return before taxes and inflation is 5% (like bonds, bank CDs, money market funds, online savings accouts like ING direct, Emigrant direct type of investments). Also assume that you are in 25% federal tax bracket and your state and local taxes are about 5%. The total taxes on the investment return are 30%. The 5% investment return gets trimmed down to 3.5% after tax is taken into the consideration.
We know that the inflation has averaged between 3%-3.5% for the last 50+ years. If you are like me and believe that the Government is low-balling the inflation numbers, you put the inflation average in the 3.5%-4% range. Taking the lower number in this range and subtracting 3.5% from our after tax return of 3.5% leaves you with nothing.
Of course, the income from the tax-exempt bonds or dividend payments from stocks are taxed at lower rates than other income instruments, but the impact of inflation is felt across the board.
After taxes and inflation, a 5% nominal return becomes 0% real return. A 5% nominal return is a break-even point.
If you earn less than 5% return on your investments, then you are in fact losing money, in real terms.