A recession or bear market are not the most significant risks investors face today. The most significant risk is, in fact, inflation.
Investors often overlook the effects of inflation because they are not immediately apparent.
A bear market, where stocks fall 20% or more, immediately has a huge and detrimental effect on your wealth.
Inflation, on the other hand, which is currently running in the region of 2% per annum in the U.S. (the annual inflation rate in the U.S. fell to 1.9% in December of 2018 from 2.2% in November), is more of a silent killer. Two percent per annum might not seem like much over the space of 12 months, but over the space of, say, a decade, it can be exceptionally damaging.
In May 1977, Buffett pending article for financial magazine Fortune, in which he alerted readers to the risks of inflation and how rising prices can hamper growth “not because the market falls, but in spite of the fact that the market rises.”
Buffett’s article goes against conventional wisdom that stocks are a hedge against inflation. In fact, he said that this view is downright wrong because “stocks, in economic substance, are really very similar to bonds.”
The Oracle of Omaha then went on to set out why he held this view. He noted that in the post-war years up to 1975, the average return on equity capital for companies in the Dow Jones Industrial Average was around 12%. Looking at these businesses as productive enterprises, not listed stocks, where owners had acquired the businesses at book value, employs a consistent return of