What we want to focus on today is how to think about investments. Specifically rates of return in the short-term versus the long-term and give consideration to factors like inflation and taxes.

Treasury interest rates are higher now than we've seen in the last 20 years. A question that may come to mind is whether one should put more or even all of their portfolio into short-term treasuries, which are currently earning between 5 to 5.5 percent.

Let's conduct an exercise on the return earned on a bond held in a taxable account. Consider a one-year Treasury bond yielding about 5.5 percent. After a year and accounting for taxes at a 30% tax rate, the effective return drops to about 4 percent. When we further extract the level of inflation, approximately 3.5 percent (Oct. 2023), investors are left with just about a 0.5 percent return on that bond. This is the real return on that bond investment after inflation and taxes.

One important distinction to understand is between nominal and real returns. Nominal return is what we see on a statement—dollars going up or down in value. In contrast, the real return is what we experience over time, as our spending needs or levels change due to inflation. Similarly, taxation affects our returns; we don't pay taxes daily, but rather at specific times during the year.

When it comes to bonds in a taxable account, gains are earned annually and added to your income. Within a diversified portfolio on the other hand, gains on the stocks are typically taxed at sale. Often the taxable amount will be at a lower rate (capital gains vs ordinary income tax), may be deferred to a time of lower income, or even used for tax favorable gifting.

Another analysis we ran is whether a Treasury bond rate of 5.5 percent is preferable to what a diversified portfolio could offer. Historically, a diversified portfolio has tended to outpace both inflation and the returns from short-term bonds.

Zooming out, while we value short-term, high-quality bonds for a portion of the portfolio, it's important to be mindful of the amount or overall percentage owned. The key to growing wealth, in our view, is by protecting near term money against market volatility, while investing in long-term growth to overcome inflation.

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