The Triple Net Return (NNN): Measuring your investment return in an inflationary environment

Photo by Sherise Van Dyk on Unsplash

Investors are currently facing the trial of dealing with inflation, a situation we have not had to consider for some time, and which may persist longer than expected. Looking at returns through the lens of a triple net return method can help investors understand the true return on investments in this new normal. 

The Federal Reserve is currently in a challenging situation. They must decide whether to continue to combat inflation by increasing rates, which could worsen the credit crunch, or to pause and provide the nation with some relief. The Fed paused recently but has hinted they are ready to raise another 25 to 50 basis points if needed. The Pandemic prompted the Fed to an explosive expansion of easing causing the Fed’s balance sheet to expand to just shy of 9 trillion USD and a bottoming of the Fed Fund’s rate to 0.25%. In 2022 the Fed took a new stance to fight inflation and set new records on how fast they would raise rates to curb inflation. 

With an inflated balance sheet now pushing the limits of the Federal debt ceiling the efforts that must be taken to solve this issue will be inflationary. There are other issues circling this problem, but let’s stay focused on the new impact of inflation on investors. Inflation is an issue that must be considered, and perhaps for much longer than most investors might prefer. It may not continue at the current high level, but we will be facing higher inflation for longer than we have in decades. 

Recently, I was chatting with a friend and successful business owner about investments and the difficulties many investors are facing. He has a lot of money in real estate, but that doesn't have anything to do with his business, so at least his main source of income is different from his investments. One of the challenges he is facing, according to his financial advisor, is investment portfolio diversification. I asked him what his advisor was suggesting he diversify into.  

“My financial advisor and I are still trying to figure out what to do. ”

His answer was similar to the stories I hear of late from investors. The first one is “My financial advisor and I are still trying to figure out what to do”. The second is that “yields in public debt instruments have not been this high for a long time and we should allocate to traditional fixed-income". Given many factors that are particular to an investor, either of these answers might not be an issue. However, for whatever path you take, a new assessment must be made, that of the impact of inflation.  

At a recent conference, investors and managers alike started to discuss the “triple net return” or “true” return of an investment portfolio. This return considers more than just fees and taxes; it also considers the inflationary impact, which has not been considered for many years. The examples below, although simple, can help you as an investor become aware of and start thinking about what's important. 

The current 1-year yield on a variety of traditional fixed-income instruments as sourced from Fidelity are as follows. 

I won't take the time to calculate the "triple net return" on these instruments. Instead, I'll just show the example below to make it clear how traditional fixed-income products would be impacted. 

10% is a solid return, depending on your risk profile and investment goals. Let’s say you pay your advisor or fund manager 2%; this is a middle-of-the-road cost, slightly more than some advisors and less than most private funds. If you buy the traditional instruments listed above, then the cost will be even lower. Most individuals accessing private funds are in the upper tax brackets, so we used an average tax impact of 30%. Unfortunately, you can no longer deduct advisor fees for tax reasons so… ouch. While historically inflation was not a concern, it is currently around 5%, and its effects may last longer than expected.  

Example:

I'm not saying that traditional fixed income should be excluded from a portfolio, or that all investments must have an expected return of more than 10%. For many, this return objective may not account for other important individual investment factors. What I'm emphasizing is that these are challenging times, and this is likely to persist into the near future. 

Investors should consider educating themselves on alternative investment options, how to access alternatives, and on finding alternatives that will meet their investment objectives and constraints. There are alternative investments both on the equity and debt side that can provide excess return while diversifying a portfolio. With some work and a good investment advisor, it is possible to create a portfolio that can increase the portfolio’s risk-adjusted return so the portfolio can maintain the purchasing power of its capital.  

As you assess the new pathways you take in your investment portfolio, this “triple net return” assessment can help you understand the “true” return on your investments in the new inflation norm. 

If you want to discuss this more, book a time for a call and I'd love to chat about it with you.