The results shown here were compiled by the Thornburg investment team and reviewed in 2008 by Dr. Bryan Taylor, a former professor of finance at California State University, Los Angeles.

Every time I have discussed the results of the study in large group presentations, inevitably a large number of advisors tell me the same thing: "I knew this intuitively, but I never had a way of explaining it until I saw the 'Real, Real Returns' chart."

There are three things that can erode the total return and value of an investment. The first is the cost of investing, or the ongoing fees charged to an investment, which can be substantial even though they have been coming down in recent years. But fees are subject to competitive factors and can sometimes be negotiable. The other two factors, meanwhile-taxes and inflation--apply uniformly to all investors.


Taxes have a detrimental effect on every investment (at least in taxable accounts). But while you can't entirely avoid or negate them, you can help stem the erosion using various portfolio management strategies to enhance total returns. You might realize long-term capital gains instead of short-term capital gains. You can use tax-deferred investments or tax-qualified accounts or place investments in appropriate taxable or nontaxable accounts. You can use investments that generate "qualified" dividend income and/or use tax-free investments instead of taxable investments-when they're not in a qualified plan or tax-deferred account. Given the wide variety of investment vehicles, as well as the different tax consequences of holding and titling investments, it is essential that the portfolio and all accounts be viewed in totality so that the overall tax impact can be better managed. While it is relatively simple to control taxes using common stocks and municipal bonds, managing taxes in alternative asset categories such as commodities or real estate can be more difficult. The management of real estate tax issues, in particular, can be difficult where debt is involved since such real estate often has negative unintended consequences in qualified retirement accounts. The current taxation of bonds and commodities can be deferred when you place them in tax-deferred accounts, but ultimately, the investment returns will be taxed when they come out of these accounts (except when they are in Roth IRAs and involved in other special types of arrangements). Similarly, long-term capital gains, which normally would be taxable at a current 15% rate if held outside of retirement accounts, could be converted to a higher normal income tax rate when they ultimately are distributed from the retirement account. These are all legitimate issues investors should consider with each investment they own. (See Figure 2.)

It's difficult to actively manage taxes in a passive environment. Within a separately managed account, taxes can be actively managed. However, within a mutual fund or other managed or pooled account, it is the investment manager who has the ultimate control over tax consequences. It is, therefore, extremely important that when considering investment managers, due consideration is given to the after-tax adjusted returns, as well as current realized or unrealized gains within the fund. Because of the wide variety of investment strategies and the wide spread of after-tax results among managers, the task of selecting investment managers becomes more challenging, but, nevertheless, extremely important.


The true impact of inflation on investment returns is rarely considered, but the real, real return study proves that inflation is indeed a serious factor that has, in many cases, deprived investors of accumulating real wealth. (See Figure 3.) While you have no control over inflation, knowing and understanding how various asset classes have performed against historical inflation rates means you can help your clients become smarter and more sophisticated investors.

An investment manager's goal is not just to make money, but also to increase wealth for shareholders and investors. To accumulate wealth, investors and advisors must use several common strategies: They identify managers with a history of generating alpha. They avoid unnecessary taxes. They must know the historic rates of return of various asset classes, and diversify among asset classes with the highest returns and lowest risk profiles. But investors' main discipline when constructing portfolios should be to consider and evaluate asset classes and historical rates of return using the concept of real, real returns. All potential investments or strategies should be analyzed within the context of returns adjusted by the costs of inflation, taxes and investment expenses. When an asset class has historically not generated returns that exceed the costs of inflation, taxes, and investment expenses-in other words, when it has not contributed to the accumulation of real wealth-it should be avoided, or at least minimized.

As investment returns move in cycles, longer periods of 20 years or more should be considered when reviewing historical rates of return. Just as the rate of stock appreciation in the '90s wasn't a realistic rate for a full 20-year period, the rate of real estate appreciation in the early 2000s was also not a long-term realistic rate-as we are quickly learning. However, over the course of 20 years, or a full investment cycle, returns are a more accurate reflection of what is likely to be experienced in the future.

As noted in Figure 4, all of the traditional asset classes have positive 20-year annualized nominal returns. However, for all but two of the asset classes, the nominal returns were cut by more than half over the past 20 years by taxes, inflation and investment expenses.

Of the generally accepted asset classes, only two have historically and consistently resulted in the creation and preservation of real wealth: Common stocks, as represented by the S&P 500 (and small-cap stocks have actually done better) and municipal bonds. The latter have a relatively high return when compared against government or corporate bonds-primarily because their returns do not suffer from the erosion of income taxes. However, municipal bonds are not totally immune from the drag of income taxes, as some may be subjected to the alternative minimum tax. As a result, even this relatively simple asset class demands more research and effort when an investor constructs a portfolio.