The Impact of Taxes and Inflation on FI Investme

Want some really bad news? If your income-stream is taxed at ordinary-income rates (currently, 25%), and if your personally experienced inflation rate is running at 5%, then the CY on your bond or pfd has to be 6.67%, or else you not even breaking even. So let work an example.

Buy a pfd at $25 par with a 7% coupon that matures in 8 years. You’re going to gross $14 bucks in divs, right? but only net 75% of that due to taxes, or $10.50. At maturity, you get back your $25 principal, now worth just $16.92 due to inflation. But your divs also have to be discounted for inflation. So your net from divs is just $8.64. Add those two together, and the net-gain on your investment is an underwhelming $0.56 cents, or roughly $0.07 cents per year for 8 years of risk, worry, and grief.

Here are my assumptions. From 30 years of tracking my expenses, I know that my personally experienced inflation rate averages around 4.5%/yr. For ongoing budgeting purposes, I round that up to 5%. For longer-range, retirement planning purposes, I’ve always notched that one number higher to 6%. Currently, the CPI is printing at 8.6%. But if the same metrics are used as were used in the 1980 version of the CPI, then inflation is running closer to 22% (or whatever number John Williams is now reporting).

In the old days, the CPI was a useful index. Though each house didn’t buy every item in the index in the same amounts as the index, the differences tended to averages themselves out. Not so these days, because the BLS --aka, the Bureau of Economic Propaganda-- has tweaked the index into near uselessness, and it uses the index to understate inflation, just as they use the GDP to overstate domestic productivity. But if “officially reported” inflation is running 8.6%, and one’s own shopping experiences at the grocery and gas pump don’t contradict that, then one’s personally experienced inflation number has to be bumped higher. So, let’s guess 6% might be one’s average over the next 5 years.

There’s a move afoot in Congress and the White House to raise taxes. My bet is they won’t be able to make it happen unless they really do want a real “insurrection”. So let’s assume that the 25% tax-rate on ordinary income stays in place.

Calculating the exact impact of inflation on the purchasing-power of one’s dollars can be done in a spreadsheet by writing formulas and populating columns. But a good enough approximation can be done with math. If the value of $1 dollar in year one is $1, then its value in year two is $0.94 cents if inflation is running at 6%. The third year, the value becomes 94% of the previous year’s value, or $0.8836. So what you have is compounding function, where the inflation for any given year is the reciprocal of the power of the inflation rate, thusly, 1/((1+I)^P), I = whatever inflation rate you want to use expressed as a decimal and P = whatever length of time you want to use, again expressed as decimal

Yeah, that bunch of symbols looks nasty. But the process is of entering them on a scientific calculator is easy.

Step One. Guess a rate a inflation expressed as a decimal. [Thus, 6%, = .06]
Step Two. Add the number ‘1’. to that. [The display should now read ‘1.06’]
Step Three. Find the key that says something like X^Y.

To test that you’ve found the right key, clear the display and enter the number ‘2’. Hit the X^Y key and enter the number ‘3’. The result should be '8", because 2^3 = 8. (I.e., 2 x 2 x 2 = 8.)

Go back to Step One. Guess an inflation rate. Add the number ‘1’. Hit the X^Y key. Enter the number of years you want inflation to run. If you used 6% inflation and five years, the display should read 1.338225578.

Last Step. Find and hit the reciprocal key that looks like this, 1/X. The display should now read 0.747258172. Move the decimal two places to the right and chop the tail.

Answer. If inflation is running at 6%, in five years the purchasing-power of your dollar has become $0.75 cents. If inflation really is running at 8.6%, then by the next presidential election, 2-1/2 years away, your dollar will only be worth $0.81 cents. And if you really want to drive yourself crazy, do a paper trade on a perpetual pfd and run the numbers to see just how much money you won’t be making unless you’re buying some really toxic, high-div trash, and then your fears shouldn’t be inflation, but the issuer defaulting.

Yeah, this post is tedious long, and the points I’m making are tediously obvious, for this reason. If I can explain this stuff to someone else, I can explain it to me. I’m worried about what lies ahead of us financially and just trying to see what can be done to limit the likely damage.


PS To estimate the impact of inflation on a multi-year income stream, discount the divs for the impact of taxes and then divide the holding period in half. That number becomes the power by which your estimated inflation rate will be raised. Not exact. “But good enough for the girls I go dancing with”, as my foreman used to say when I was booming out, overhauling turbines, and life was far simpler.


If your income-stream is taxed at ordinary-income rates (currently, 25%)

Not sure what ordinary income rates you’re talking about, but there hasn’t been a 25% bracket since 2017, and under current law, won’t be a 25% bracket again until 2026. The current brackets are:


So even if all of your divys are taxed at ordinary income rates, you’d have to have taxable income well over $200k (single, HOH) or $400k (MFJ) to have an effective 25% rate. That said, many preferreds pay qualified dividends, which have their own tax brackets, the same as capital gains:


So if your income was mostly qualified divys, you wouldn’t even get to a 25% marginal rate, much less a 25% effective rate.

Sorry, your analysis is unrealistic.




Thanks for the correction.



It seems both of us are wrong. Most divs paid by pfds aren’t qualified, and the diff between an ord income rate of 22% and 25% isn’t material, not when I understated the likely inflation rate.

But whether my original numbers were correct or not, the underlying idea is useful, which is this.
“Safe” rates of return from FI won’t offer a real rate of return after taxes and inflation. Higher rates carry risks that are likely to trash the whole investment.

As always, anyone can disagree and they should disagree , because there is no one right way to do any of this investing/trading stuff. But check where the market is at this morning in pre-session trading. The salad days are gone. Now, the game is survival.


A follow-up.

Though preferred stock dividends are fixed like interest on a bond, they are taxed differently. Many preferred dividends are qualified and are taxed at a lower rate than normal income. Except for investors in the highest tax bracket who pay 20% on qualified dividends, most preferred shareholders owe only 15%. People in ordinary income tax brackets at 15% and below pay no tax on qualified dividends.…

It’s good news that the tax situation isn’t as grim as I thought. But the hurdle to achieve a real rate of return after taxes and inflation is still formidable. So let me run the analysis again. Buy a $25 pfd at par, with a 6% coupon, due 10 years out, that pays quarterly non-qualified divs. If the tax rate is 85%, and if inflation runs at an average of 6% per year over the 10-year holding-period, then the “investment” will result in a loss of purchasing-power. (Run the numbers yourself.) But if the coupon is 6.42%, then the investment breaks even on an after-taxes, after-inflation basis.

Depending on whose scanner you use --and whether converts and exchange-traded debt are included in the list-- somewhere between 575 and 730 items will be returned. If you use Stock Market MBA’s list and rank the output by coupons, only 45% make the cutoff, which confirms my suspicion that --in the present investing environment-- making a “safe”, real rate of return from fixed-income instruments --in Graham’s sense of the term ‘Defensive’-- is hard to do. If a real rate of return is wanted/needed, then a lot of risk has to be accepted.

So, what are those ‘risks’? ‘Call risk’ (which is easy to manage). ‘Tax risk’ (which is known and won’t likely change). ‘Inflation risk’, which is a "known “unknown”, as is ‘interest-rate risk’, both of which contribute to ‘market risk’, which is yet another “known unknown”. Whatever the Fed does or doesn’t do this week will likely trash the prices of stocks and bonds and set up a negative feedback loop in which rising interest-rates and/or untamed inflation further trashes an already weak domestic economy, never mind the currency wars and sanctions wars that Biden is losing that are eroding the reserve status of the $US dollar.

Yikes! What’s a fellow to do? The obvious answer --to me, anyway-- is to start hedging, because the Fed is clueless, the Congress indifferent, and the White House irrelevant. The three of them are going to let the economy crash and blame it on Trump or Putin (or whatever), instead of fixing the problems they themselves created, chiefly, the policies and actions they have funded in the belief that “deficits don’t matter”, to which the obvious counter-reply is this. “If deficits don’t matter, can I stop paying taxes?”

My worry is this. If inflation runs no higher than 6% to 8% per year, and if I do no more than break even on my investments, then my present assets and income-streams fund my retirement to age 113, or one year longer than the world’s oldest male, meaning, I won’t become a financial burden on my kids or have to go on the dole. The world’s oldest woman is/was 122. That might seem extreme or unusual. But my great-uncle, Jack, lived to 103 and his sisters to 109 and 111. So funding a long, long retirement is a problem I’ve been dealing with a lot of years and why I don’t like the uncertainties of the present situation and keep scrambling to figure ways to deal with them.


It seems both of us are wrong. Most divs paid by pfds aren’t qualified

Really? How do you define ‘most’? Because when I look at Quantumonline’s table of all preferred stocks… there are 335 issues that say they are not eligible for the 15% rate vs. 469 that say they are eligible for the 15% rate. That’s 58.33%, which rates as “most” in my book.

the diff between an ord income rate of 22% and 25% isn’t material

Except it’s more likely to be a 15% (or 0%) rate, depending on your income. That is material.




Again, much thanks for your push back. I, too, would like to think that preferreds are a viable path to appreciating capital, or at least preserving it, because I own a lot of them and intend to acquire more. But I become an investing pessimist when I run the tax and inflation numbers for preferreds and am exploring more viable vehicles.


But I become an investing pessimist when I run the tax and inflation numbers for preferreds…

Moi aussi, pretty much. Many trade “by appointment only” and with large bid/ask spreads. Because demand for them tends to be light, they can drop like rocks in time of market unrest. Most eventually recover, but if the objective was to avoid turbulence, they won’t do that.

That said, I still have small positions two preferreds: CHSCO and CHSCN. CHS is the largest ag co-op in the U.S. (hence not a publicly traded company, although the preferreds are), based in MN. Backed by silos of soybeans. I’d buy more, but it’s difficult to execute anything more than small buys, so I put it off. Oh, well.

Many preferreds are thinly traded. Limit orders are recommended.

Market orders can be disaster. Market maker can make whatever price he chooses for your trade.

"Many preferreds are thinly traded. Limit orders are recommended. Market orders can be disaster. Market maker can make whatever price he chooses for your trade.


I strongly disagree.

To date, I’ve bought a hundred or so preferreds, most of them very thinly traded. Maybe half the time I use market orders, because a penny or two either way won’t matter, and I need to get the execution done, because I’ve got another dozen positions I want to put on. E.g., today I did 35 buys, though a typical day is closer to five or ten. I’m executing mainly through Schwab, Firstrade, and TD and always getting very fair fills.

Yes, there are times when limit orders should be used, and that has nothing to do with how thin the trading volume is but --as you implied-- with how wide the spread is, which is easy to see before the order is written. But even then, market orders often get a better execution than trying to be too clever by half with limit orders.

I don’t remember the ticker, but the bid x ask was something like 20.10 x 20.20, which invites using a limit order and splitting the spread. So that’s how I wrote it. NO FILL. So I rewrote to 20.16. NO FILL. I went to 20.17. NO FILL. Disgusted, I rewrote as ‘market’ and got a fill at 20.15. And this isn’t the only time that’s happened.

Why? I have no idea. But I do maybe 500 trades a year, and nearly always regret not using a market order from the getgo if the spread isn’t abusively wide and the order queue is tight. But, also, I’m trading off of a 1-minute chart, so I have a pretty good sense of where the market is and a what a fair fill should be when I’m submitting orders.


Your mileage may vary, Arindam.

When I look at the 30 day chart on DDT, I see spikes across the chart. That is bid ask spread market orders. A limit order takes some patience but usually gets your trade in at close to the last buy or sell.

Sure if bid ask is narrow a market order is fine. But that is not always the case.


You can’t trust charts to tell you where you could have gotten in or out, because the spikes are outliers. Nor does T&S report what’s really happening, because just round lots are reported, and a lot of trades are done in “dark pools”.

The bottom line is this. If you don’t like using market orders, then don’t use them. But let others decide for themselves what works best for them.


The data indicate with DDT that a market order costs you about $0.50/share or 1.9%.

Limit orders work fine for thinly traded stocks. Average volume for DDT is 8406 shares.

“The data indicate with DDT that a market order costs you about $0.50/share or 1.9%.”


Trying to claim that “the data” say such and such is as ridiculous as the pro-vaxxers trying to claim that “the science” says that mNRA technology is safe. Right now, at 10:05 EST, DDT is 25.95 x 26.28, with a last of 26.022.

Market orders are NEVER filled at the ‘ask’. Always, there is ‘price improvement’. The improvement might be slight. But it always happens. So let’s say a would-be buyer does submit a market order , which he/she should NOT be doing given the wide spread. What’s the worst that could happen? A fill at 26.28, right? In such a case, by how much he/she “overpay”. That’s hard to say, because he/she would NEVER get filled at the bid, but something between the split and the ask.

The spread is 0.33. The split would be 26.115. If the buyer got 26.25, the “overpay” would be .135 cents, which as a percentage of the purchase price, would be 44 beeps, not your exaggerated 1.9%.

Second, wide spreads are NOT caused by illiquidity, but by market makers, because I can point to plenty of situations where the EFT almost trades by appointment only, but the spread is a very tight, one penny wide. That’s what would-be buyers need to pay attention to. If the spreads is tight, using a market order causes little harm and might actually result in a better fill than trying to be clever with limit orders. (I’ve experienced this too many times for it to be denied.) OTOH, when spreads are wide and the trading in that security isn’t “orderly”, then limit orders should be most definitely be used. But they need to be intelligently placed limit orders, or else you won’t get a fill.

All of the preceding is merely a report of my experience. Each person will have to decide for her or himself what makes the best sense to do.


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All sorts of things happen.

I have had the experience of having a market order fill at a spike above previous trades and then immediately return to the previous trend.

Limit orders are safer.