How Much Minimum Returns required to beat the Inflation and Taxes?

Does inflation erode wealth? Learn how to calculate the minimum required rate of return to protect your purchasing power.

Don't just look at the headline return when making investment decisions. You must consider the tax-adjusted real rate of return to truly secure your financial future and grow your wealth.

Inflation is a monster that devours your investment gains. The rising cost of living causes your money to buy less over time. As a result, if your investments do not outperform inflation, the real value of your wealth will decline.

To avoid this, aim for a rate of return that covers your investment expenses while outperforming inflation. This will safeguard the true value of your investments and preserve your purchasing power.

But inflation isn't the only beast to be concerned about. Taxes can also significantly reduce your investment returns. Because different tax brackets have different rates, it's critical to understand how these rates affect your returns.

Calculate your tax-adjusted real rate of return to get a clear picture of how much money you'll actually make after taxes.

Here's a table that shows the minimum rate of return you need to keep your invested capital safe, based on your tax bracket (excluding any surcharges that may apply to incomes above Rs. 50,00,000):

Before making any investment decisions, it is critical to understand these factors. Knowing the rate of return required to maintain the real value of your investments as well as the after-tax income you'll receive will assist you in selecting the best investment strategies for your needs.

Keeping a close eye on your tax-adjusted real rate of return can also assist you in optimising your investments. You can improve your overall financial performance by minimising the impact of taxes on your returns. This means more money in your pocket and, potentially, a faster path to meeting your financial objectives.

The following table shows the minimum returns you should earn to beat inflation with adjusting tax expenses.

All figures are in per cent

How to calculate:

Minimum Required Rate of Return = Inflation / (1 – Effective Tax Rate)

Let’s consider that we fall in the 3^rd tax bracket of Rs. 7.5 Lakh to Rs. 10 Lakhs where the Tax rate is 10 per cent and Cess 4 per cent. So effective tax rate will be,

Effective Tax Rate = Tax Rate * (1 + Cess)

Effective Tax Rate = 10 per cent * (1 + 4 per cent)

Effective Tax Rate = 10.40 per cent

Now to calculate Minimum Required Rate of Returns we already have formula,

Minimum Required Rate of Return = Inflation / (1 – Effective Tax Rate)

Minimum Required Rate of Return = 4.87 per cent / (1 – 10.40 per cent)

Minimum Required Rate of Return = 5.44 per cent

So, as per calculation, we must earn a return of more than 5.44 per cent to beat inflation and tax payments otherwise we end up eroding our wealth.

So, don't just focus on the headline return when you're making investment decisions. Take the time to calculate your tax-adjusted real rate of return. It's an important step in making informed investment choices and securing your financial future.

Disclaimer: The article is for informational purposes only and not investment advice.

DSIJ’s ' Upstream Pick’ service recommends well researched contrarian stocks with high potential and high reward. If this interests you, do download the service details here.