After factoring in inflation and taxes most investments barely break even. I have discovered an alternative investment strategy that generates tax-free income and automatically keeps pace with inflation. These characteristics make the gains from these investments several times higher than the heavily taxed and inflated investment vehicles you see promoted on CNBC.

There is one source of income that is very real, but never shows up on your taxes. A dollar saved is really a $1.25 earned after taxes. If you were able to produce everything you ever wanted on your own, then you would never pay a dime in taxes. No one is able to produce everything, but there is a way to produce a large part of your needs.

Disclaimer: what follows is my opinion. The powers that be do not permit me to give investment advice. Please make your own decisions and consult with the so-called professionals. I am not responsible for any losses that you incur by investing as described below.

Own your Home

Owning your home earns you a virtual income equal to the rent you would pay to live someplace else. There is no way around needing a place to live. Assume for a moment that your home could be rented for $1500 per month. To get that $1500 you must either sell your time or earn a return on your investments worth $2000 / month or more (before taxes).

Buying a house isn’t cheap. So the question is, will investing $300,000 in stocks and bonds be better than buying your own home? To make this comparison we assume that owning a home costs $600 / month in property taxes, insurance, and maintenance. This means the initial monthly benefit relative to renting is $900 / month. This produces a 3.6% per year rate of return on $300,000. Critically, this rate of return is after taxes, inflation, and depreciation.

If you put your $300,000 into bonds, then you would need to earn at least 3.6% interest to match owning your home. But that will only cover you the first year. Rents are climbing at 4% per year. This means you will need to earn 7.6% to keep up with inflation. Lastly, you will need to earn enough to pay taxes on your gains so this will require bonds paying 9.5%.

What we can conclude from this is that owning your home is the investment equivalent of investing at 9.5% per year. There is one critical difference, the income from owning your home is more or less guaranteed and extremely low-risk compared to the risks you must take to earn 9.5% in the market. Anything paying 9.5% interest will have a very real default rate. Perhaps the clearest example of this is Lending Club. The loans they fund typically pay the lenders 14%, but suffer a 5% default rate and have other fees which result in savers earning just over 8% by making high-risk loans. This shows you how risky it is to seek after 9.5% returns.

Shielded from Inflation

Real estate and rents tend to rise with inflation. There is a constantly growing population looking for places to live that will drive long-term demand. This means that your original capital will likely grow with inflation and the population. All of the calculations above have already factored in the cost to maintain your home (replacing appliances, heating and air, roofing, etc). A well maintained home will not deprecate much.

If the inflation rate were to suddenly rise your home investment would automatically keep up. Meanwhile everyone else investing in stocks and bonds will have to increase their gains and then pay taxes on the extra gains just to keep up. All of this in a market that is likely suffering from the ill effects of inflation.

Produce your own Electricity

When it comes to investments, solar power is one of the most overlooked and under appreciated. A 10 KW solar system can be installed for $30,000 after tax rebates. This system will produce $120 / month worth of electricity. This represents a 4.8% after-tax rate of return on investment. The astute observer will note that this is 33% better investment than owning your own home. Electricity rates have been rising at an average of 3.6% per year which means that each year your solar panels will save you more.

You would have to invest your $30,000 at 13% just to keep up with the return you are getting on your solar investment. Once again, the risk profiles are vastly different. Solar is a very reliable and secure investment, where as anything offering 13% returns is going to be high risk.

If you need to sell your house, then you will likely recover 50% of your original capital. So while the pay-back period is 20 years at todays electric rates, it is much shorter once you factor in the retained value of the panels, the expected inflation rate, and compare it to the after-tax rate of return of alternatives.

Should I Borrow to buy a House or Solar?

At today’s record low interest rates, borrowing money to buy a $300,000 house will cost $800 per month in interest. Critically, a 30-year fixed mortgage locks in todays rates and interest. If you are planning on living in one place for 30 years then this might make sense. However, I would caution anyone from using leverage in this market.

You can refinance an interest rate, but you cannot refinance the principle. If and when interest rates rise it is very possible that real estate prices will have to fall. Falling real estate prices doesn’t usually mean falling rents. If you must sell your house while prices are low then you can lose everything. If you don’t have to sell, then the current market price doesn’t really mean anything to you. You are still getting the benefit of free rent and fixed mortgage payments.

Debt always increases risks. Your best bet is to buy the cheapest home you can and pay it off as quickly as possible. This will allow you to minimize risk and maximize your savings rate.

Downsides

There are a few downsides to buying a home and solar. Perhaps the most significant is the need to make a long-term commitment. The cost of moving could cause you to lose 10% of your capital each time and/or force you to sell at an inopportune price.

Conclusion

When making investment decisions it is wise to consider things you can buy that will save you money before even considering things that will earn you money. These physical assets can generate tax-free income and will appreciate with inflation. Every other investment option out there is burdened by taxes, inflation, and high risks.