Mrs. Steiner, a middle-aged almanah, had “nechasim da’agos.” The life insurance payout she’d received after her husband’s petirah was still sitting in a cash account, earning nothing. While she’d been too numb to think about this during the aveilus, it was time to face reality. That pot, which had to last until 120, wasn’t even keeping up with inflation. And from the way the powers that be in Washington, DC, had been acting lately, it seemed probable that inflation would skyrocket. If so, was her cash in grave danger? How can investors prepare for potential runaway inflation?

Stagflation 2.0?

Money in the bank may seem super-secure, but if, over time due to inflation, your cash buys you less and less stuff, that’s a loss of wealth. While inflation has been tame for decades, from 1972–1981 the US dollar lost almost half its value (see A1 in chart.). In 1980 alone, the value of the dollar fell by 14%! This “Great Inflation” was a financially devastating time period—which some fear we may be doomed to revisit soon. Let’s review how various asset classes performed during America’s most recent period of significant dollar erosion.

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Line 1 on the chart lists annualized investment returns during the initial “stagflation” period, when inflation skyrocketed from 2% to over 14%. Line 2 showcases the next decade, when inflation was blunted and fell drastically (after interest rates were raised to double digits!). Line 5 encompasses the whole 20-year time period. Lines 3 and 4 are presented cumulatively and after subtracting the effects of inflation (or what professionals call the “real” return). These two lines highlights how painful and volatile an inflationary environment was to investors. And the data as a whole points to some practical guidance for investing in the face of inflation.

Cash is not too bad

Interestingly, cash (in this case, represented by money market funds) didn’t do badly at all during the 1970s and 1980s despite the high inflation. Why? Rates paid by banks on liquid savings rose as quickly as inflation did, so savers earned double digits in the early 1980s! (Sounds like a dream, right?) As you can see (B1, B2 compared to A1, A2), cash yields surpassed inflation during that time period.

Bonds were busted

Most bond investors, however, get rates that are locked in for years. Therefore, when inflation rises unexpectedly, the real (net of inflation) value of bonds plummets. Intermediate-length treasury bonds lost about 3% (real) per year between 1972 and 1981 (C1 minus A1). During the worst four-year stretch, the real loss was a whopping 28% (C4), not the type of loss conservative bond investors anticipate. On the other hand, when rates fell throughout the 1980s, a reverse effect occurred: bonds did surprisingly well, earning over 10% after inflation (C2 minus A2).

Stocks had mixed results

Most businesses struggle with inflation—costs of labor and raw materials often rise faster than the prices customers are willing to pay. The difference equals a hit to profits, and less profits usually translates into lower stock prices. The stock market managed to break even after inflation during a very volatile time period in the first half of our saga (D1 minus A1). But then it roared back to life, gaining a stellar 16.3% (D2) annually from 1982–1991! Those who stomached the entire span gained 11.9%, almost double the inflation bite (D5, D1).

Real estate is pretty great

Real estate (as represented by REITs, or real estate mutual funds) also did quite well during the inflationary upheaval (E1, E2, E5). The value of land and bricks and mortar tends to grow with inflation, and landlords can raise rents accordingly. This is especially true for housing. Since a roof over a head is an unavoidable expense and residential contracts are relatively short-term, apartment owners are in a strong position to pass inflation increases on to their tenants. (We will revisit this in a future article, adding the perspective of personal homeownership.)

Gold shines, then shatters

Many assume that gold is the ultimate inflation fighter, and indeed, it boomed at the outset of the 1970s (F1). But as inflation started receding, the price of gold collapsed. The loss of about 5% of the value of gold per year after inflation from 1982–1991 (F2, A2) put a real dent in its reputation as a reliable guarantor of asset values. It can still be a worthwhile portfolio diversifier in limited quantities.

Commodities crushed it

It’s easy to understand why commodities (basic raw materials like metals, fuels, and grains) were the top performers of the time period. Unlike gold, people must always keep purchasing commodities to survive. The prices of these raw materials rose dramatically during each of the two decades (G1, G2), while its falls, though stiff, were among the lowest of the bunch (G3, G4). Keep in mind, though, that like gold, commodity prices eventually collapsed too, when inflation did. Timing still matters, and getting it wrong can be extra costly within this unique investment category.

Some intriguing takeaways

So what’s the bottom line? First, cash did a lot better than I’d have expected. Second, long-term, all the categories beat inflation (line 5), though they did experience periods of significant losses (line 3)—also surprising. Finally, assuming that historical precedents hold, a long-term, diversified investor may not have to fear inflation that much. Check out column H, which highlights a portfolio composed of 50% US stocks, 20% intermediate treasury bonds, and 10% each of REITs, gold, and commodities. This portfolio got very solid returns (H1, H2, H5) while experiencing much less volatility than the other categories (except cash, which has limited upside potential).

Two important caveats But as investment advisers never fail to warn clients, past results don’t guarantee future returns. The world has changed in many ways with the introduction of negative interest rates, cheap alternative energy, smartphones, the euro, and even bitcoin, as well as myriad other factors that impact inflation which didn’t exist the last time around. The upcoming potential inflation spike may therefore unfold very differently. Another thing that didn’t exist then is Treasury Inflation Protected Securities (TIPS), which are government bonds with inflation protection. I therefore couldn’t chart their history for this analysis, but these complicated securities definitely belong in the inflation-fighting arsenal. Perhaps we’ll follow up on this in a future column