Double Trouble: Watch Out for Taxes and Inflation

It isn't what you make. It's what you keep.

Let's say you bought a bond with a top-notch credit rating that's yielding 2%. Seem like a safe investment? That may indeed be true over the short-term. But the longer-term story could be quite different.

To understand why, suppose you're in the 25% federal income-tax bracket and inflation continues at its current 1.4% annual clip. After surrendering 25% of your annual interest earnings to Uncle Sam, you would be left with 1.5%. Next, subtract out the hit from inflation. Result: You're barely breaking even.

This isn't intended as a knock on bonds. Given today's low yields, the math is even worse for savings accounts, money-market funds and certificates of deposit. Meanwhile, if you own stocks and the market takes a tumble, inflation and taxes would likely be the least of your worries.

That said, stocks do at least offer the chance to earn high returns--and thus the potential to fend off the threat from inflation and taxes over the long haul. That doesn't mean you should invest everything in the stock market. But if you're a long-term investor and you want a shot at earning inflation-beating post-tax returns, allocating part of your portfolio to stocks could be a wise move. Just make sure you are comfortable with the risk of investing in stocks, including the potential for steep losses.

Not willing to buy stocks? To ensure you keep more of whatever you make, you might strive to limit the damage done by taxes. To that end, consider making the most of retirement accounts. A Roth 401(k) plan or Roth Individual Retirement Account can give you tax-free growth, while a traditional 401(k) or IRA can give you both an initial tax deduction and tax-deferred growth. Add in the matching employer contribution that many 401(k) plans offer, and your results could look even better.

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The information provided is solely for informational purposes. It is not an offer to buy or sell any of the securities, insurance products, investments, or other products named.

CDs maturing on or before December 31, 2013, are insured by the FDIC up to $250,000. Through December 31, 2013.

Diversification does not protect against loss or guarantee a profit.

Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

There is no guarantee that these strategies will succeed. This information is intended to illustrate products and services available through Citigroup Global Markets Inc. The strategies do not necessarily represent the experience of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies presented are not appropriate for every investor. Individual clients should review with their Financial Advisors the terms and conditions and risks involved with specific products or services.

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