When Stocks Lose to Inflation

Stocks are often held in retirement because they are expected to beat inflation over long periods of time. While they generally do, there have also been periods of rising inflation in which stocks suffered poor returns in the face of rising living costs. This is the worst-case scenario for retirees.

The period from 1968 to 1982 was particularly bad. Even taking just 4% initial distributions, an investor with $1,000,000 in the S&P 500 ended the period with roughly $288,000 in 1968 dollars. 

That retiree lost more than 70% of the portfolio's real starting value.

Ironically, while bonds traditionally offer lower real returns, if that investor had held a portion of their portfolio in more conservative treasury bills, they would have seen a smaller reduction in real wealth. If the portfolio began with 75% in the S&P 500 and 25% in Treasury bills, rebalanced annually, the ending value rises to roughly $344,000 in 1968 dollars.

That's still a massive loss, but consider what would have happened over the next 10 years. 

By 1992, the all-stock portfolio was down to to $109,000 (in 1968 dollars), while the 75/25 portfolio was worth $185,000. 

I get that this still isn’t a dream scenario. It’s still a bloodbath, albeit slightly less of one. 

But it’s noteworthy when a less risky portfolio delivers higher ending wealth. And importantly, that higher ending wealth creates more financial cushion for the retiree. 

What else helped through this period?

Treasury bills were not the only assets that improved a portfolio during this period.

Gold performed extraordinarily well during much of the 1970s, along with broader commodities, due to the surge in energy and raw-material prices.

Real estate had some ability to adjust through rising rents and property values.

Foreign stocks also provided exposure to economies and currencies outside the United States where stock returns were more favorable. 

None of these assets provided a perfect hedge, and each carried risks of its own.

But I see this as a case study in the value of diversification. 

Diversification is especially important for retirees. 

Owning a single-asset-class portfolio is similar to owning stocks on margin because the timing of your returns starts to become really important. You can't wait out a bear market; you need the money now. 

However, just because there is a bear market in one asset class doesn't mean all asset classes are similarly impaired, or that a broader portfolio will go through the same downturn. T-Bills offer some breathing room. Real estate and commodities are driven by a different set of macroeconomic variables, and foreign stocks offer some currency diversification at a time when your local currency is depreciating rapidly.

I don't necessarily think the takeaway from 1968 is that retirees should prepare for a 1970s-style inflation shock. That's probably an oversimplification. But it's great to keep that period in mind as an example of, "we don't know what's coming next." 

Instead, you want to own a mix of assets so that you'll own enough of whatever does well over the next 14 years, without owning so much of anything that a bad stretch can derail the whole plan.