Investments and Inflation Protection

As discussed in January 25’s post, inflation is just about inevitable. The nominal value of your investment may increase, but if it does not increase at a greater rate than inflation, its real value—its purchasing power—actually diminishes. So ideally you want your investments’ total return to exceed the rate of inflation.

How well do stocks and bonds achieve that goal? Historically stocks have done a better job of out-pacing inflation than bonds. Consider these statistics over the years 1926 through 2008. Stocks are represented by total return on the S&P 500; bonds are represented by total return on intermediate term Treasury bonds; inflation is represented by changes in the Consumer Price Index.

Geometric average annual nominal returns
Stocks: 9.62%
Bonds: 5.44%
Inflation: 3.01%

Geometric average annual real (inflation-adjusted) returns
Stocks: 6.42%
Bonds: 2.25%

Number of years (out of 83) experiencing a real (inflation-adjusted) loss:
Stocks: 27 (33%)
Bonds: 32 (39%)


The figures above look just at single-year periods. But that's short-sighted. Tomorrow’s post will take a more realistic look at how well stocks and bonds have increased purchasing power by analyzing longer periods.