This article is an excerpt from the Shortform book guide to "The Intelligent Investor" by Benjamin Graham. Shortform has the world's best summaries and analyses of books you should be reading.
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What’s the connection between inflation and investment? How can understanding inflation help you make better investments?
Inflation and investment are connected because both affect the state of the economy. You may find it more difficult to invest or see investments change due to inflation.
Read more about inflation and investment below.
Inflation and Investment
Inflation is an increase in prices over time. A dollar today buys a lot less than a dollar did 20 years ago: the purchasing power of a dollar has decreased. This is why it’s important to think about inflation and investment.
Inflation is an insidious problem, because it doesn’t change the actual balance of your bank account, it only changes the purchasing power of how much money you have. If 2% of your bank balance were deducted per year, you’d take notice and be alarmed. But when the same amount of money can buy 2% less in goods and services each year, it’s nearly undetectable.
Therefore, if you were to hold all of your savings simply in cash, it would gradually lose value because of inflation. In contrast, holding stocks in your portfolio reduces the effect of inflation. Even if inflation occurs in a given period, increases in the stock’s dividends and price may offset inflation. Bonds, being loans with fixed terms, don’t have the same flexible resistance to inflation.
We’ll discuss inflation in more detail and why stocks protect against it.
Measuring Inflation
How bad can inflation get? During certain periods, inflation can be rapid:
- In the US, in the 6 years from 1915 to 1920, cost of living nearly doubled.
- Also in the US, in the 10 years from 1973 to 1982, cost of living more than doubled.
- Zweig notes that since 1960, two-thirds of market economies have experienced inflation of at least 25% per year for at least a year. The US hasn’t yet experienced this, but it’d be unwise to assume it could never happen.
Averaging across much of the 20th century, Graham predicts that a reasonable assumption around inflation is 3% per year. (Shortform note: Since the start of the 21st century, inflation has stayed at a relatively steady 2% per year.) So when it comes to inflation and investment, you’ll have to find good stocks to invest in.
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