So with all this talk about stock market returns and fears of inflation stalling out the market, I decided to do a little research on the topic of inflation. They say that between 2-3% inflation is the sweet spot for where economists like to see the inflation come in at. The thought is that it allows just enough room for price appreciation without putting pressure on corporate profits. This got me wondering what does inflation look like over the past 100 years. It’s interesting to see how inflation has gone up and down over the years. From the chart below, you can see how we’re really living in a time of low inflation. I can’t imagine the stress inflation caused families in the early 20th Century dealing with double digit inflation.
If you’d like to see the monthly and annual #’s, check out this link Historic CPI
I was interested to look at the rate of return of the S&P over the years. When you adjust for inflation, the real rate of return drops dramatically. Even the first chart below, doesn’t seem to clearly show the true impact. So I plotted the data out in terms of what the return of $100 invested in 1950 in the S&P 500. Over the course of 68 years would have gone up 15.6 times in 1950 dollars vs. 161 times without adjusting for inflation. 15.6 times is good, but that’s the equivalent of 4.13% annual rate of return. Thus with the S&P returning about 7.76% annually since 1950, you’re losing a good chunk of that return to inflation. I’ve always targeted my FIRE # as $2 M in the year I graduated $’s, hopefully inflation remains in this historic low period. What’s your FIRE #?
So then I broke the data down by 10 year periods, which revealed some interesting fact.
Even though we’ve been in a relatively low level of inflation, the 10 year return has been pretty close to the historic average. Noted when you look at the #’s excluding 2007, the rate of return jumps from 4.45% to 11.25%. Maybe that will lead me into another topic later, how 1 bad year can really mess up your rate of returns. How do you account for inflation in your investment portfolio?