There's another reason investors overlook the important of inflation: what psychologists call the "money illusion."
If you receive a 2 % raise in a year when inflation runs at 4%, you will almost certainly feel better than you will if you take a 2% pay cut during a year when inflation is zero.
Yet both changes in your salary leave you in a virtually identical position -2% worse off after inflation.
Inflation eat away at that number in secret. Inflation just takes away our wealth.
It's so important to measure your investing success not just by what you make, but by how much you keep after inflation.
More basically still, the intelligent investor must always be on guard against whatever is unexpected and underestimated.
Can the intelligent investor do to guard against inflation?
The standard answer is "buy stocks" -but, as common answers so often are, it is not entirely true. The historical evidence is clear: Since the advent of accurate stock-market data in 1926, there have been 64 five-year periods (i.e., 1926-1930, 1927-193, 1928-1932, and so on through 1998-2002).
In 50 of those 64 five-year periods (or 78% of the time), stocks outpaced inflation. That's impressive, but imprefect; it means that stocks failed to keep with inflation about one-fifth of the time.
Just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket-neither in the bond basket, despite the unprecedentedly high returns; nor in the stock basket, despite the prospect of continuing inflation.
- The Intelligent Investor, Benjamin Graham
