Intelligent Investor Chapter 2 Summary: The Investor and Inflation

The Investor and Inflation


They will fluctuate - J.P. Morgan

  • Popular belief is that stocks offer protection against inflation in the form of advancing dividends and prices of shares. Common stocks in general have performed better than bonds in long term. But it's not advised to have an all-stock or even all-bond portfolio(Why? keep reading).
  • Inflation and common stock earnings-price relationship has been almost non-correlational. Stock prices have fallen despite inflation. Theoretically, inflation should increase the value of existing capital and thus rate of earnings. But this effect has been minimal probably because of offsetting influences like increasing wages and need for huge new capital.
  • Alternatives to common stocks as Inflation hedges:
    • Gold-storage expenses, 2% of total assets- so that losses aren't huge, but returns will be bright if it does well.
    • Real estate-location, price misjudging - be careful.
  • Don't put all eggs in one basket.

Commentary:

  • Some goods have become lot cheaper like computers and electronics providing more quality too. So consumers are getting more value for their money.
  • Not what you make(absolute/nominal), how much you keep after inflation(real) matters. If your pay increased by 2% and inflation by 4%, it is same as getting a cut of 2% in your pay with no inflation.
  • Inflation is good for government that borrows money(debtors). Deflation is good for creditors - so bonds protect us from deflation.
  • Mild inflation allow companies to pass off the increased cost of raw materials to customers, but high inflation forces customers to slash their purchases.
  • Alternatives to protect against inflation:
    • REIT(Real Estate Investment Trusts) - Mutual funds that invest in companies that own and collect rent from properties.
    • TIPS(Treasury Inflation Protected Securities)- US Govt bonds that go up as inflation rises. But this increase in value is taxable even when not sold - so this is better for tax-deferred retirement accounts. 10% of retirement assets is a good option as these are volatile in short term, but work better in permanent holding.
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See Intelligent Investor Summary for other chapters summary.

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