Inflation and Stocks: What’s the Deal?

I believe that if you really want to create and build wealth, you have to have a plan where your money is growing steadily in both good times and bad.

One of the things that I always thought was deadly for stock investments was inflation. For me, inflation was bad for stocks and good for bonds. And with inflation higher than it was last year, I’m concerned about what rising inflation can do for my stocks.

So, when I saw an article by Paul J. Lim on today’s NYTimes.com, I had to read it.

And as for my belief that “inflation is bad for stocks and good for bonds”, this article proved me wrong – to a point.

It said that inflation is “not necessarily” bad for stocks.

In fact, it said that in the 23 years between 1926 and 2007 when inflation was more than 4% (that seems to be the magic number), stocks returned an average of 6.9% while long-term government bonds returned a measly 2.8%.

The article goes on to give a pretty detailed analysis of what happens to stocks when inflation is low or high, and whether it’s moving up or down.

It uses 1980 to show us how even with high inflation, stocks can still do well. Extremely well in this case. In 1980, the Consumer Price Index rose more than 12%, but stocks gained an average of 32%. The reason? It could be because the year before, 1979, inflation was higher at more than 13%.

Very interesting.

If you want a good primer on the effects of inflation on your portfolio, check out the article. And let us know what you think. Inflation just not be the portfolio killer that I always thought it was.