
Investor & Inflation — Chapter 2
Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling .
This is the basic definition of Inflation.
To explain in simpler terms, if a chocolate worth $1 today would be worth $1.05 by next year, then inflation in 5%.
Because of inflation the returns from investments can potentially be cancelled out . It has to noted that the biggest loss is incurred by the Fixed income investments and bonds as rates are pre-determined . This makes stocks as preferred means of investment than bonds.
Effective Rate of return = Expected Rate of Return — Inflation rate
Despite this general consensus, there have been instances where bonds have had better returns against stocks.
Now question arises if, our portfolio should comprise of all-stock or all-bond or mix to sustain the inflation fluctuations.
Keeping the past instances in mind, investor should allow probability of inflation trends to recur and modify portfolio accordingly.
Common stocks may do better sometimes, high-grade bonds can do better at other times.
Impact on Corporate Earnings
There was no relation observed in rate of earnings of business to increase with economic activity.
The absence of any sign that the inflation of a comparable amount in the past has had any direct effect on reported per-share earnings
The only way that inflation can add to common stock values is by raising the rate of earnings on capital investment.
The stock market has considered that the public-utility enterprises have been a chief victim of inflation, being caught between a great advance in the cost of borrowed money and the difficulty of raising the rates charged under the regulatory process
Alternate Investments
Unlike the liquid investments of stocks and bonds, one can also consider investments in non-liquid assets like those of precious metals, like gold, and also real state.
As a long term investment, above non-liquid assets have also proven a good investments in long run. But real estate and land investments have higher risk of going wrong because of external factors of getting place or time wrong and also political factors.
So diversification, with sound knowledge and reasoning, is a necessary part of investor’s portfolio.
Just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket
