One of the main reasons we NEED to invest is to beat inflation’s constant erosion of value. Money in the bank may seem super-secure, but if, over time, due to inflation, your cash buys you less and less stuff, that’s a loss of wealth. The world got a small taste of high inflation in the aftermath of COVID upheavals. But that brief foray into high inflation was nothing compared to some historical episodes. For example, from 1972–1981 the US dollar lost almost half its value (see A1 in chart.). In 1980 alone, the value of the dollar fell by 14% (B1)! This “Great Inflation” was a financially devastating period, which some fear we may be doomed to revisit soon.
Seems Safe. But Is it?
Imagine someone inherits or saves up a million dollars and decides to collect long-term guaranteed passive income. A 30-year US treasury bond will offer them about $50,000 annually in mid-2025. This investing plan may seem like the safe way to go, until you consider inflation. Locking in your income for decades means inflation is virtually guaranteed to degrade your buying power/ wealth—a real risk.
Let’s review how various asset classes performed during America’s most recent period of significant dollar erosion. It can be illustrative of how we can invest today for inflation protection.
Chart Navigation
Line 1 on the chart lists annualized investment returns during the initial “stagflation” period, when inflation skyrocketed from 2% to over 14%. Line 2 showcases the next decade, when inflation was blunted and fell drastically (after interest rates were raised to double digits!). Line 5 encompasses the whole 20-year time period. Lines 3 and 4 are presented cumulatively and after subtracting the effects of inflation (or what professionals call the “real” return). These two lines highlight how painful and volatile an inflationary environment was to investors. And Line 5, the data as a whole, points to some practical guidance for investing in the face of inflation.
Cash Is Not Too Bad
Interestingly, cash (in this case, represented by money-market funds) didn’t do badly at all during the 1970s and 1980s despite the high inflation. Why? Rates paid by banks on liquid savings rose as quickly as inflation did, so savers earned double digits in the early 1980s! (Sounds like a dream, right?) As you can see (B1, B2 compared to A1, A2), cash yields surpassed inflation during that period.
Bonds Were Busted
However, most bond investors get rates locked in for years. Therefore, when inflation rises unexpectedly, the real (net of inflation) value of bonds plummets. Intermediate-length treasury bonds lost about 3% (real) per year between 1972 and 1981 (C1 less A1). During the worst four-year stretch, the real loss was a whopping 28% (C4), not the type of loss conservative bond investors anticipate. On the other hand, when rates fell throughout the 1980s, a reverse effect occurred: bonds did surprisingly well, earning over 10% after inflation (C2 less A2).
Stocks Had Mixed Results
Most businesses struggle with inflation—costs of labor and raw materials often rise faster than the prices customers are willing to pay. The difference equals a hit to profits, and less profits usually translate into lower stock prices. The stock market broke even after inflation during a very volatile period in the first half of our saga (D1 less A1). But then it roared back to life, gaining a stellar 16.3% (D2) annually from 1982 to 1991! Those who stomached the entire span gained 11.9%, more than double the inflation bite (D5, A5).
Real Estate Is Pretty Great
Real estate (as represented by REITs, or real estate mutual funds) also did quite well during the inflationary upheaval (E1, E2, E5). The value of land and bricks and mortar tends to grow with inflation, and landlords can raise rents accordingly. This is especially true for housing. Since a roof over one’s head is an unavoidable expense and residential contracts are relatively short-term, apartment owners are in a strong position to pass inflation increases on to their tenants.
Gold Shines, Then Shatters
Many assume that gold is the ultimate inflation fighter, and indeed, it boomed at the outset of the 1970s (F1). But as inflation started receding, the price of gold collapsed. The loss of about 5% of the value of gold per year after inflation from 1982–1991 (F2, A2) put a real dent in its reputation as a reliable guarantor of asset values. It can still be a worthwhile portfolio diversifier in limited quantities.
Commodities Crushed It
It’s easy to understand why commodities (basic raw materials like metals, fuels, and grains) were the top performers of the period. Unlike gold, people must always keep purchasing commodities to survive. The prices of these raw materials rose dramatically during each of the two decades (G1, G2), while its falls, though stiff, were among the lowest of the bunch (G3, G4). Keep in mind, though, that like gold, commodity prices eventually collapsed, too, when inflation did. Timing still matters; getting it wrong can be extra costly within this unique investment category.
Some Intriguing Takeaways
So what’s the bottom line? First, cash did a lot better than I’d have expected. Second, in the long term, all the categories beat inflation (line 5), though they experienced periods of significant losses (line 3), which is also surprising. Finally, assuming that historical precedents hold, a long-term, diversified investor may not have to fear inflation that much. Check out column H, which highlights a portfolio comprising 50% US stocks, 20% intermediate treasury bonds, and 10% each of REITs, gold, and commodities. This portfolio got very solid returns (H1, H2, H5) while experiencing much less volatility than the other categories (except cash, which has limited upside potential).
Two Important Caveats
However, as investment advisers never fail to warn clients, past results don’t guarantee future returns. The world has changed in many ways with the introduction of negative interest rates, cheap alternative energy, smartphones, the euro, and even bitcoin, as well as myriad other factors that impact inflation, which didn’t exist a half-century ago. Today’s potential inflation spike may unfold very differently. Another thing that didn’t exist then is Treasury Inflation Protected Securities (TIPS), which are government bonds with inflation protection. I, therefore, couldn’t chart their history for this analysis, but these complicated securities definitely belong in the inflation-fighting arsenal.
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