Understanding Inflation, Part 2: To Beat Inflation, Invest in the Stock Market
In my last post, we talked about whether higher inflation may be about to awaken after decades of slumber. The truth is, nobody knows. But if you’re worried about inflation, invest in stocks.
For example, in the U.S., items costing around $1 in 1970 cost almost 7 times as much, or nearly $7, in 2020. That’s an average 3.9% annual inflation rate. However, depending on the category and assuming reinvested dividends, stock values increased from 100 times over for U.S. large-cap growth stocks (9.4% annual return) to 674 times for U.S. small-cap value stocks (13.6% annual return). And dividends paid by the S&P 500 companies increased from $3.19 in 1970 to $58.28 in 2020—an 18-fold increase.
In part, stocks significantly outperform inflation because inflation itself helps the overall average performance of the stock market. Although there is usually a lag, eventually businesses pass increased costs along to consumers. This increases sales and average profits, which equates to higher stock prices and dividends.
What about shiny rocks … er, gold, an assumed inflation fighter? The price of gold increased 53 times over from 1970–2020, or an average annual return. Sounds pretty good as an inflation hedge, but it’s not that simple, nor as strong as stocks. Due to highly inconsistent correlation rates between gold and inflation, you can’t depend on it when needed. In the 1970s, as inflation doubled costs, gold did increase by almost 15 times to more than keep pace with inflation. But in the 1980s, costs increased 65% and gold fell 23%. In the 1990s, costs increased 33% and gold fell 27%. And gold isn’t even an investment in my book. Unlike stocks or real estate, gold neither produces nor provides anything of substance. And there can be a cost to store it.
What percentage of your wealth to allocate to stocks depends on your personal goals. But as long as you have enough time to let those allocations ride through the downturns, you can expect them to remain well ahead of inflation, with no fancy market-timing moves required or desired.
What if you’re a retiree, or otherwise depending on your portfolio to provide a reliable income stream here and now? We’ll cover that in a final installment in this series on understanding inflation.
John A. Frisch, CPA/PFS, CFP®, AIF®, PPC™ founded Alliant Wealth Advisors in 1995 and has over 30 years of experience as a financial professional. In his free time, he’s an avid long-distance runner, a sport that requires discipline, patience and vision. John applies these same skills to his professional pursuits: He helps families and retirement plan sponsors adopt a patient, disciplined approach to overcoming financial challenges and reaching their distant goals along a clear path. Learn more at www.alliantwealth.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.