KeystoneExplorer | Winter 2021-22 21 finances While it is a great accomplishment to achieve financial freedom, it does not make you wealthy. It just means that you have enough to cover your expenses without working. With inflation, financial freedom won’t last very long unless you build up your net worth and create the buffer you need to live without financial worries. The beauty of financial freedom is that your money works for you instead of you working for money. As my friend and mentor, Robert Helms says, “It’s like your dollars go to work for you and come home with friends.” The strategy that is commonly used by retirement planners is to have you invest in stocks, bonds, and mutual funds, to accumulate enough to withdraw about 4% per year, and hope it doesn’t run out. Cashflow vs Networth Investing The traditional method requires a large amount to accumulate compared to a cash flow model of investing. The idea is to find investments with cashflow until the stream of cash covers all your living expense and then continue until you have a buffer of cash flow that will support your retirement lifestyle. Many advisors suggest that your budget or expenses will drop when you retire, but I would disagree. Once free from working, you will have the opportunity to travel and participate in leisure activities. You will likely develop some new hobbies and have some related additional expenses. It usually requires significantly less net worth using the cashflow model. Also, if some of the cashflow investment are real estate or other real assets there will be appreciation and equity building up as well. The real estate acts as a hedge against inflation while the stock bonds and funds do not. Leverage to Build Net Worth Because of inflation, it is challenging to grow your net worth using strictly investments like CDs and other interest earning investments. If you find a CD that pays 4% but the real interest rate is at 10%, you are losing spending power. You would need 10% just to break even. How can we get around this? The answer is leverage or debt. For example, you could buy one house for $100,000 cash and it might cash flow $200 per month. But using debt we can put down 25% on four $100,000 houses and borrow 75% giving you a cash flow of $800 per month. If the houses double in value to $200,000 over ten years we still only pay back $75,000 per house. We add the appreciation to our net worth. It is possible to do the same thing without the hassle of owning houses, but that is for another day. During times of high inflation you will pay back your loan in devalued future dollars but the asset will retain its intrinsic value. It will be worth more of those deflated dollars. Using debt is the best way of overcoming the effect of inflation Reduce Taxes Another way to beat inflation is to reduce taxes. The number one largest expense for everyone is taxes. Your total tax rate can be over 50%. Believe it or not, the IRS tax code has a very small section on how to calculate the taxes you owe but the rest of the tax code is filled with ways of reducing your taxes. The government uses the tax code to create the behavior they desire. For example, the government doesn’t want to be in the housing business or the oil exploration business. There is a tax incentive for investors to encourage them to do both of these things. If these tax deductions drive oil exploration and rehabbing houses in rundown communities then government does not have to spend any money doing this. The private sector does it more efficiently. It is important to understand what tax savings are created by certain investments. There are investments that allow you to deduct 2–5 times the amount you invest. So it is important to spend some time learning how to invest using these deductions. Hedge Against Inflation And finally, I present a defensive strategy. Consider buying 5–10% of your portfolio in precious metals as a store of value. Understand the dollar is a fiat currency and not really money. Gold and silver serve as the best example of money. Gold has held its value in purchasing power well over time. In Roman times you could by a formal toga and good sandals for an ounce of gold worth $1,800 today. For a similar amount of money, you could by a nice suit and a pair of good shoes. Should the dollar collapse, an ounce of gold will still have the it original purchasing power. I hope you now have some ideas to mute the effects of inflation. I have introduced the strategies of cash flow vs. net worth, leverage, tax mitigation, and investing in precious metals as a hedge. It is up to you to learn how these strategies can be used to defeat the inflation thief. Eric N. Shelly DMD, MAGD PAGD Treasurer CEO Freedom Impact Consulting LLC eric.shelly@freedomimpactconsulting.com
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