The Law of Zero Return - or why investing is apparently stupid...(?)

Ok so I link you to this.
Personally, I have never actually heard about it.

Since I have always thought that investing (broadly speaking) was a good idea – better than saving in some cases due to inflation etc. – it kind of surprised me what this guy was saying.

Given the rate of taxes + inflation, do most people stand to lose out on thier returns-on-investment(s)?
See I always thought that as a general rule since the cost of living decreases (e.g. the basic cost of goods and items goes down as production & tech go up) over time, that money in real terms could buy you more stuff - even though technically it was valued at less.
Does this guy’s analysis hold up? I’m too drunk to notice.
What’s the straight dope here and how well established a principle is the Law of Zero Return?

– Encouraged reading from link:

200% of Nothing by A. K. Dewdney

Just taking a quick look at that link, it seems a bit of a fallacy. It recognizes the effect of inflation on the original stake when you’re investing and therefore suggests that investing isn’t a good idea. But what’ the alternative? Socking your money away in a bank account or under your mattress? If you do that, inflation devalues it just the same, and you’re not getting any ameliorating interest. I guess you could just spend everything as soon as it comes in, but you’d better not plan on retiring, or buying a house or car, or getting sick.

It also seems to miss that interest compounds, but I didn’t spend enough time looking to see if I’m right about that.

He does make a good point that inflation pushes people into higher tax brackets over time as long as they’re not indexed. But in practice, that doesn’t seem to be that big a deal, because cutting taxes is very powerful as a political platform. So the brackets probably will get adjusted to inflation from time to time, although it’ll be a very roguh process. Of course, in the recent past we’ve seen tax cuts that are quite dramatic and go much further than just correcting for inflation pushing up the brackets.

He also misses that there are ethical and moral reasons for supporting a progressive tax even though it costs money to people who have money. There are political arguments against this stance, certainly, but he has to, you know, make them. Instead he states that a progressive tax is progressive and thinks he’s proved something. Well duh. There’s no such thing as a free lunch.


My financial advisor (the guy at my Credit Union, he’s free) explained it this way.

Mutual Fund=~5% (there are lots of variables in this one)
Real Estate=~6%
Interest on Money Market Account=~0.85%

If you are letting your money sit in a savings account, you are losing 3-0.85=2.15% of your purchasing power. If you are in a conservative mutual fund where you are earning 3% you are neither gaining nor losing. If you are in a more agressive fund or real estate you are gaining 2-3% purchasing power.

It made sense to me, but I almost failed Intro to Macroeconimcs in college, too. I believed him enough to buy a condo.

Translation: This so-called law has neither theoretical nor empirical validity. It is pure rhetoric.

The underlying issues are real though, albeit poorly expressed.

Let’s say inflation is 2% and a money market fund pays 3%. Your inflation adjusted return is 3-2=1%, right?

Right. But that’s not your return after taxes. To keep the numbers simple, let’s say the State and Federal government takes 50% of your last dollar. [sub]This would not apply during the GW Bush era - heck, it probably wouldn’t apply in the Clinton era once you consider that state taxes are deductable on your federal return, but bear with me anyway.[/sub]

You earn 3% on your savings ; the governments take 1.5%; you’re left with 1.5-2 = negative 1/2% after inflation. Bummer.

So what should our hapless upper-middle or upper income person do? That’s easy: simply choose tax-favored investments. Municipal bonds are tax-free at the federal level.

Stocks are even better. First of all, the tax rates are lower on them. Secondly, you only pay the tax bill when they are sold. By postponing taxes, you allow more compounding and a higher after-tax return. Of course, you do have to take on some additional risk.

Buying a home also has tax advantages: you get the benefits of the tax treatment of capital gains (as with stocks) in addition to the government subsidy of mortgage payments (via Schedule A, 1040).

His example uses a CD. That’s not investing. On average, throughout modern history, if you are getting 8.75% on a CD, then “real” investments are getting significantly more, as xbuckeye pointed out. There are some good points in here about the effects of inflation and taxes on salary and purchasing power, but that is only weakly-related to investing.

Right at the beginning, he mentions this:

Isn’t he calculating the “devaluement” entirely incorrectly? By his simplistic thinking, if there was 100% inflation, your $10000 would be devauled by $10000, which isn’t true.

If my calculations are correct, 4.4% inflation means that $9579 worth of pre-inflation stuff now costs $10000 (9579 * 1.044 = 10k) meaning that if there is 4% inflation, your $10000 is devalued by $421, not $440. If he makes a mistake on something this simple, I’m certainly not going to take any of his more complicated claims on faith.

The author might reply that he was using approximations (4.2%, 4.4%, what’s the diff? (ignoring compounding of course).)

Then again, his website is devoted to math mistakes: it would be better if wrote with greater precision and circumspection.

If you look at it realistically, it’s nonsense.

OK, say inflation is 4%. What does that mean, in the blue-sky, carbon-based world we inhabit? All prices rise 4%? Nope, only that all price increases over that period of time average out to 4%.

Well, how about the long-term? WAG says “probably not.” Historically, gas prices are below what we expected to pay. Even with the recent hikes, they’re still below. Food prices are not as high as they were in the '70s. Housing prices are, but tax rates have been cut, and depending on your income and accountant, there are ways to defer or reduce your tax bill.