Are You On The Path Of Going Broke Safely?

by Jeffery A. Keill CFP, CIM, FMA,FCSI

Are you Going Broke Safely?

The affects of Tax-flation, that is the combined financial erosion of your wealth generally results from disconnected emotions of short term safety from the truths concerning long-term wealth creation. The irony of this is staggering. By letting emotions control our decisions, play it safe, ultimately you are most likely to experience failure in the long run. Walking to Cuba is safer than flying (so some would think), but really it is not safer and in the long run (or walk in this case) you will find yourself drowning.

The truth is that real wealth is created over time by investing not based on emotions but letting logic and the evidence that supports it to guide your decision. We are creatures whose behavior is so often guided by fear of loss and potential for gain.

We are fearful because of lack of experience. Let me share a short story about perceived risk. Not so long ago when my daughter was about 4 years old we watched a baseball game together on TV. Really, I watched the game and she just played with her toys. When it was time for her to go to bed I sent her on her way down the hall ahead of me. I explained I would be there in a minute or two. I watched as she walked down the dark hallway and suddenly stopped and came running back into my arms. It was cute moment for sure between a father and daughter but it was a most obvious display of experiencing the fear of the unknown. I took my daughter by her hand and we walked together down the hallway and into her bedroom, which too was dark and scary for her. I could feel her hand gripping mine as we walked into darkness. I turned on the light and reassured her there was no boogie-man or ghost about to swallow her up whole. To her I was so brave. When I was her age I had the same fear. What changed? Education and experience. Over the years I had encountered many dark rooms and have yet to be swallowed up. My fear dissipated over time and by the time I was a father, I was able to guide my daughter confidently into the dark.

Investment risk is much the same. With little experience around the dark room of investments we see only the worst that could happen. With fear we ignore historical evidence and toss logic to the wind as we contrive of every possible booggie-man that is going to grab us from under the bed. In truth, there seldom is a booggie-man. Of course there is always perceived risk and these can be fabricated out of news stories or from bias sources who use fear as a sales tool. There has and always will be a soup-de-jour of some perceived risk. Today is no different than periods in the past, although people tend to think today is different. It is the same circus just with different clowns.

By playing it safe with your investments, which mean avoiding loss at all costs, actually means that- it will be at all costs. You will lose money. Seeking safety today means acknowledging lower returns today. When you take tax and inflation into consideration, you are putting yourself in a position of watching your real wealth decrease and over time you will go broke with this approach. Imagine a return on a $10,000 deposit earning 5%. This 5% would equate to $500 in interest. Unfortunately, $500 of interest is taxable. If the marginal tax rate is 40% you would have to pay $200 in tax thereby reducing your interest , you have spend to only $300. If inflation rate is 3.5% you need $350 just to keep up your spending power. You only made $300 but you need $350. This is how your wealth erodes and over time you will go broke by always choosing safe investments.

Seeking higher returns over time however does not mean accepting higher risks over the long run. As a matter of fact, longer term investors experience very low probability of loss and as the time horizon gets extended out the risk continually decreases. Investing in things that appreciate in value such as real estate and quality businesses (or shares of companies) has proven to consistently over time to grow faster than inflation as well as having some of the income tax preferred. This tax preferential treatment reduces the effects of taxation.

Before you decide to make a deposit into a GIC or High Interest Savings Account, consider the affects of tax-flation and if this short term deposit truly matches up with your financial goals. As often is said in our office, “Successful investment outcomes results when we let logic triumph over emotion”.

Contact our Wealth Advisory to learn more about this topic or click the link to view our Serious Money Brief Discussion Paper: Tax-flation and Going Broke Safely.

Last Edit Feb 3,2025