Inflation risk- cash vs stocks?

[Katoslake]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.

Which result is better given our inflationary climate?
Is it only when stock values surpass fixed values that it’s a win vs inflation?
Unless an investment is outpacing inflation then you are still losing, it’s only a question of by how much.

Please explain why my thought process is flawed.

 

[cbo111]

You accurately state the fundamental dilemma of investing.

 

[Koolau]

Yeah, these are "bad times" for investors. We've had it good for 10+ years. Now, it's gonna be grit your teeth and hold on. In this particular situation, cash is good so you don't have to sell your stocks which will (with any luck) recover in a few years. The fact that our cash is taking a hit due to inflation is unpleasant in the extreme. Hopefully, you enjoyed your helicopter money 'cause now it's time to pay the piper. There's no such thing as free money. YMMV

 

[Montecfo]

It is more interest rate risk than inflation. Rising rates will continue to weigh on stocks, especially the high PE stocks. But high duration bonds will be hit also.

But as long as you hold quality and limit speculative positions, you should do fine. As far as inflation, it will moderate. We see signs of that now. But interest rates have a way to go.

You will not make money on all markets, but limiting losses makes sense too. My bond allocation is in floating rate securities, CDs and low duration Treasuries.

 

[FLSUnFIRE]

Cash is a "risk free" guaranteed loss at current inflation/interest rates (unless in iBonds and your personal inflation matches but that is only treading water). Market has a higher expected return over the long term with much more risk.


I'm pretty immune from emotional responses to market shenanigans (a little less so now that I'm dependent on my portfolio) but if I want to make myself feel better I look at the PE of the market... it's always a little better after a drop!



If I knew what was going to happen, I'd be a Trillionaire and not here so there you go....

 

[Car-Guy]

Yeah, these are "bad times" for investors. We've had it good for 10+ years. Now, it's gonna be grit your teeth and hold on. In this particular situation, cash is good so you don't have to sell your stocks which will (with any luck) recover in a few years.

We are not even close to the massive downturn we lived through in most of 2020 due to Covid... That was just two years ago! If folks didn't panic and sell then, I'm not sure why they would now. YMMV

 

[pb4uski]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.

Which result is better given our inflationary climate?
Is it only when stock values surpass fixed values that it’s a win vs inflation?
Unless an investment is outpacing inflation then you are still losing, it’s only a question of by how much.

Please explain why my thought process is flawed.

The best thing is to look at real returns, which is nominal return - inflation. So if inflation is 7% and the nominal return on CDs is 2% then the real return is -5%. If SPY has a nominal return of -20% and inflaton is 5% then the real return is -27%.

 

[finnski1]

The best thing is to look at real returns, which is nominal return - inflation. So if inflation is 7% and the nominal return on CDs is 2% then the real return is -5%. If SPY has a nominal return of -20% and inflaton is 5% then the real return is -25%.

Yep. Certainly been a double whammy YTD

 

[Koolau]

The best thing is to look at real returns, which is nominal return - inflation. So if inflation is 7% and the nominal return on CDs is 2% then the real return is -5%. If SPY has a nominal return of -20% and inflaton is 5% then the real return is -27%.

Now there's a cheery thought. As nearly as I can tell, there are relatively few ways to protect ones self at this time which is why I suggested we're living through some tough times. Most investments are going down. We had it good for a long time and now we're taking a hit. I would say I'm surprised it didn't happen sooner, but what do I know (and YMMV)?

 

[ERD50]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.

Which result is better given our inflationary climate?
Is it only when stock values surpass fixed values that it’s a win vs inflation?
Unless an investment is outpacing inflation then you are still losing, it’s only a question of by how much.

Please explain why my thought process is flawed.

I assume you are referring to the oft-stated comment that stocks are a hedge against inflation?

It is true, but that statement doesn't provide enough context. It's true over the long run, but often times, *not* over the short run.

The way I look at is, the long term gain in stocks has been high enough to help the portfolio survive over long runs of inflation. Those gains may happen prior to the inflation run, so it boosted the portfolio going in. Or it may happen later, helping the portfolio to recover. It may or may not happen during the inflationary period.

This tool makes it easier to see specific years:

https://ficalc.app/

I change the default spend to $34,000, so 100% success with their default 80/15/5 AA. Click on "1966" and you see it ends the 30 year cycle at $164,070.

Now change the AA to 20/75/5, "1966" goes to zero two years before the end of the 30 year cycle.

Yet, in 1973 and 1974, inflation was 8.7% and 12.3%, while S&P total return was NEGATIVE 14.66% and NEGATIVE 26.47%. But over the long run, stocks helped beat that inflation.

https://www.slickcharts.com/sp500/returns
https://www.macrotrends.net/2497/historical-inflation-rate-by-year

-ERD50

 

[HarryHawk]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.

Which result is better given our inflationary climate?
Is it only when stock values surpass fixed values that it’s a win vs inflation?
Unless an investment is outpacing inflation then you are still losing, it’s only a question of by how much.

Please explain why my thought process is flawed.

Inflation is an equal opportunity destroyer of wealth across all your assets. Whether your assets are in cash or stocks, your dollars are worth less in terms of absolute value than they were previously.

In your example, you stock portfolio is down 20% and is further reduced by the inflation rate when compared to what you could purchase a year earlier.

 

[Koolau]

Yet, in 1973 and 1974, inflation was 8.7% and 12.3%, while S&P total return was NEGATIVE 14.66% and NEGATIVE 26.47%. But over the long run, stocks helped beat that inflation.

-ERD50

Of course, I totally agree. But at some point, long run may not fit one's own time frame. I think about that at 75 where I didn't at 25 when the last big stagflation hit. Then again, old age might be your friend. Not so much worry about your stash lasting 30 years (though my plans is STILL to 99 which is 24 years!) I think we may be living in interesting times but YMMV.

 

[pb4uski]

Now there's a cheery thought. As nearly as I can tell, there are relatively few ways to protect ones self at this time which is why I suggested we're living through some tough times. Most investments are going down. We had it good for a long time and now we're taking a hit. I would say I'm surprised it didn't happen sooner, but what do I know (and YMMV)?

That's why it is best to look at equity returns over 3, 5 or 10-year periods rather than 1-year or YTD or briefer periods.

 

[arcyallen]

We are not even close to the massive downturn we lived through in most of 2020 due to Covid... That was just two years ago! If folks didn't panic and sell then, I'm not sure why they would now. YMMV

Guessing your fellow investors future behavior is indeed a most impossible thing to do. The markets "should" have crashed super hard and stayed down in the spring if 2020. They didn't. That was my personal "We've entered into irrational exuberance" red flag. A red flag with strobe lights and sirens. But again, guessing what people will actually do now is STILL a crapshoot!

 

[ERD50]

Of course, I totally agree. But at some point, long run may not fit one's own time frame. I think about that at 75 where I didn't at 25 when the last big stagflation hit. Then again, old age might be your friend. Not so much worry about your stash lasting 30 years (though my plans is STILL to 99 which is 24 years!) I think we may be living in interesting times but YMMV.

OK, so do a run for 24 years, and see what AA has help up in historical times. Add some margin if you think "interesting" means "worse than the worst of the past" (which it may well be - who knows?).

-ERD50

 

[zekeboz]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.

Which result is better given our inflationary climate?
Is it only when stock values surpass fixed values that it’s a win vs inflation?
Unless an investment is outpacing inflation then you are still losing, it’s only a question of by how much.

Please explain why my thought process is flawed.

I think you are missing the one key variable - time. When do you need access to the funds? If 4-5+ years then I would argue Stocks are better than CDs, the average recession lasts 18 months.

In addition the double whammy of high inflation would be buffed by stocks whereas in a CD it would be negatively impacted, rates are nowhere at the level today to outpace current inflation. For reference in the early 80s I had a 3 year CD earning 11%.... which was inline with inflation at the time. Today there is a delta of at least 2-3x of inflation over cd rates. They have a long way to go.

 

[NW-Bound]

"Inflation risk- cash vs stocks?"

Inflation erodes the value of cash slowly.

But the specter of inflation hurts stocks with a quick punch to the guts.

It follows that you could have lower losses by going to cash temporarily, then switch back to stocks when the latter stabilize.

But of course, market timing is tough and requires some luck.

 

[daylatedollarshort]

TIPS and I bonds with real yields are outpacing CPI inflation, and the zero real yields are at least keeping up. Our fixed mortgage rate at under 3% is looking pretty sweet right now. Individual bonds and Treasuries held to maturity and redeemed at par may have negative real interest rates but nowhere near the losses many bond funds are chalking up. We have always been fans of matching strategies. Not a huge upside like stocks, but it does well with high inflation - Matching strategy - Bogleheads

 

[Magus]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.

Which result is better given our inflationary climate?
Is it only when stock values surpass fixed values that it’s a win vs inflation?
Unless an investment is outpacing inflation then you are still losing, it’s only a question of by how much.

Please explain why my thought process is flawed.

Stocks do not tend to do well in inflationary environments for two reasons 1) CAPM model has values dropping as higher risk free rate AND higher required market returns drives much higher required return on equity 2) Many, many stocks are hurt by margin compression in an inflationary environment.

 

[Katoslake]

The best thing is to look at real returns, which is nominal return - inflation. So if inflation is 7% and the nominal return on CDs is 2% then the real return is -5%. If SPY has a nominal return of -20% and inflaton is 5% then the real return is -27%.

This is exactly the reason that I think it’s odd for people to criticize cash or fixed positions. It’s definitely market timing, but minimizing loses can be a win given this S show

 

[Ready-4-ER-at-14]

Need help with my understanding of current environment and relative risk.

Say you have $100k in CD’ s or something similar
Then you have $100k in SP 500 index fund.

Index fund loses 20%. CD’s remain stable.


Please explain why my thought process is flawed.

I just wanted to comment on this part of the statement re cd's remain stable
We have a longer term fixed income ladder that includes cd's and things like treasuries. Ive decided to get even most of the fixed income in regular iras into roths which will incur a tax bill. To pay that i am selling some of them.

Despite CDs paying the face value at maturity, the value today is definitely affected by the markets. There is a penalty if interest rates go up in the amount you get selling early. Say the cd is 1% below current cd rates and goes out 7 years you will lose somewhere around 7% ( 1% compounded 7 times). Since interest rates are still going up the buyers will want some sort of discount as well. This works the other way as well if interests rate drop suddenly you may well be able to sell over the face value at maturity.

The change in value is significant enough that I will wait towards the end of the year to move them cheaper if inflation and interest rates keeps charging upwards.

 

[copyright1997reloaded]

Disclaimer: I'm not saying this decade will be a repeat of the 70's, but here's what did well/not so well in the 70's:
- Overall stocks - not so well, Dow Jones index started at 809 and ended at 839. A rather large loss overall after inflation.
- Real Estate - some good some bad: Some parts of the country did well (those getting large population inflows like silicon valley. Other parts of the country, housing did not keep up with overall inflation. Farmland did well.
- Commodities - overall did well. Corn, wheat all went up much more than overall inflation.
- Energy companies did well (in 1980 almost 30% of the SP 500 market cap was energy stocks...it is now 5.18% even AFTER the big run up this year which is still LOWER than 12/31/18 weight of 5.31%)
- Gold did well (up from $37 or so to about $400).
- Silver did well (up from $2 to $30 or so)

 

[Koolau]

Disclaimer: I'm not saying this decade will be a repeat of the 70's, but here's what did well/not so well in the 70's:
- Overall stocks - not so well, Dow Jones index started at 809 and ended at 839. A rather large loss overall after inflation.
- Real Estate - some good some bad: Some parts of the country did well (those getting large population inflows like silicon valley. Other parts of the country, housing did not keep up with overall inflation. Farmland did well.
- Commodities - overall did well. Corn, wheat all went up much more than overall inflation.
- Energy companies did well (in 1980 almost 30% of the SP 500 market cap was energy stocks...it is now 5.18% even AFTER the big run up this year which is still LOWER than 12/31/18 weight of 5.31%)
- Gold did well (up from $37 or so to about $400).
- Silver did well (up from $2 to $30 or so)

If I had to place a bet - and I guess we all have to - this is a pretty good place to start. No insights, but but when inflation rages, people tend to want "real" things (land, food, PMs, oil, etc.) Paper - not as much, though you never know and therefore YMMV.

 

[Magus]

Disclaimer: I'm not saying this decade will be a repeat of the 70's, but here's what did well/not so well in the 70's:
- Overall stocks - not so well, Dow Jones index started at 809 and ended at 839. A rather large loss overall after inflation.
- Real Estate - some good some bad: Some parts of the country did well (those getting large population inflows like silicon valley. Other parts of the country, housing did not keep up with overall inflation. Farmland did well.
- Commodities - overall did well. Corn, wheat all went up much more than overall inflation.
- Energy companies did well (in 1980 almost 30% of the SP 500 market cap was energy stocks...it is now 5.18% even AFTER the big run up this year which is still LOWER than 12/31/18 weight of 5.31%)
- Gold did well (up from $37 or so to about $400).
- Silver did well (up from $2 to $30 or so)

Residential Real estate generally kept up with or exceeded inflation nationally (more than doubled 1975-1985), and adjusted for leverage most folks have, actually increased quite a huge amount more. Commodities were quite choppy and stagnated for a long time after that so not sure they will do as well this time.

 

[arcyallen]

Disclaimer: I'm not saying this decade will be a repeat of the 70's, but here's what did well/not so well in the 70's:
- Overall stocks - not so well, Dow Jones index started at 809 and ended at 839. A rather large loss overall after inflation.
- Real Estate - some good some bad: Some parts of the country did well (those getting large population inflows like silicon valley. Other parts of the country, housing did not keep up with overall inflation. Farmland did well.
- Commodities - overall did well. Corn, wheat all went up much more than overall inflation.
- Energy companies did well (in 1980 almost 30% of the SP 500 market cap was energy stocks...it is now 5.18% even AFTER the big run up this year which is still LOWER than 12/31/18 weight of 5.31%)
- Gold did well (up from $37 or so to about $400).
- Silver did well (up from $2 to $30 or so)

Don't forget back then dividends played a much bigger part than then do today. I can't easily find performance numbers for the the DJIA, but the S&P500 more than doubled during the 70s, averaging about a 7.8% return. I'm sure the DJIA performed similarly. And gold...yikes...in a vacuum those numbers sound fantastic. But that's also measuring to a peak in 1980 that, if you'd bought then, you have have been underwater for 25 years. No growth, no dividends, no nuthin' - just waiting and petting the pretty metal.

It's always helpful to look at a decade of performance, but it's critical to look at the decades before and after to get a more thorough picture.