Inflation: The Silent Killer That Will Murder Your Returns

Inflation should be the main thing all investors are worried about. Forget bad company news. Forget lower-than-expected GDP growth. Forget 0.00001% lower fees if you switch to a different index fund. Inflation is the silent killer of returns. This is why William Bernstein names inflation as one of 4 “deep risks” that investors should be worried about and should try and guard against in his book Deep Risk. In fact, he comes to the conclusion that inflation is the most likely of these deep risks and the cheapest to protect against (1).

Portfolio value with portfolio growing at 5% and different levels of annual inflation vs. years.

Inflation erodes the value of your hard-earned savings. It’s the reason you can’t have all your money under the mattress or in a low-interest savings account. It forces us to take more risk for fear of the real value of your wealth being eroded. You think tax is theft? Inflation is worse. Think of all that hard work you put in to accumulate your wealth. It could all be for nothing. The value of this wealth can be eroded very quickly indeed. All it takes is a bit of consistent inflation.

Terminal value of a portfolio after 20 years growing at 5% vs. different levels of annual inflation.
The 70s

“But Haydn, inflation has been low for years!”

Correct. But those who do not learn from history are doomed to repeat it. Leaving other disastrous inflationary situations in other countries aside, for now, we need only cast our eyes back 50 years or so. Let’s look at the UK in the 70s. A decade of power cuts, rubbish on the streets, and ghastly punk music. But these were not the worst things about the 70s. Inflation was running rampant.

Annual UK CPI inflation rate in the 1970s. Source: ONS.

You see, high inflation is a very real (do you see what I did there?) prospect. It may seem like a very unlikely outcome in the present climate, but it’s out there. Lurking. Ready to rear its ugly head at any moment.

Institutional intervention

The paranoia is compounded by the fact that inflation is significantly influenced by the actions of the government and the central bank. By treating the economy like a machine that can be fine-tuned and controlled these institutions have been playing with monetary and fiscal policy in a reckless manner. Trying to eradicate the business cycle is an insult to the organic nature of the economic system. Growth at all costs via monetary and fiscal intervention severely distorts the natural processes of the economy. This hides/suppresses risk in the system and leads to ever-larger catastrophes. High inflation, or hyperinflation, is one of these potential catastrophes.


Hyperinflation can be defined as more than 50% inflation per month. It has some disastrous effects. Your life savings become worthless. Banks go bankrupt as people stop depositing cash. The domestic currency gets absolutely fucked. Overall, very strange things happen as the economy struggles to function as an actual economy. Not a pleasant situation.

There are many famous incidences of hyperinflation to look at. From the Weimar Republic in the early 20th century, to Mr. Mugabe’s Zimbabwe in more recent times. However, I want to look briefly at South America in the 70s, a somewhat lesser-known incidence.

Many of the South American countries ran up huuuuuge debt in the 70s in an attempt to maintain growth after oil-price shocks and silly macroeconomic policies. Governments were forced to print money to pay off debt denominated in foreign currency. This led to massive devaluation of the domestic currencies as the fiscal deficit was financed via printing presses (this is typical of hyper-inflationary incidences). As the currencies became more and more devalued, nominal price levels rose more and more. This is a vicious cycle that eventually led to hyperinflation.

Latin America and the Caribbean: annual inflation rate in %. Source: ECLAC (chart taken from this report).

In a study of hyperinflation in South America originally released in 1986, Gerald Swanson recounted the effects of this hyperinflation in Argentina, Bolivia and Brazil, coming to the conclusion that weird shit happens. The price of bread, for example, changed twice a day. Wages had to be linked to prices otherwise people would starve. Life became all about the next day, next 3 days and the next week.

This is the point that is most important for us as lifetime investors. He observed that any type of long-term planning became impossible. People are simply not thinking about the long-term, because you can’t. If I don’t know the price of bread next week, how am I supposed to think about my life in 20 years time?! Lifetime investing becomes a fruitless task.

Portfolio value with portfolio growing at 5% and hyperinflation scenario (50% monthly inflation) and no inflation vs. years.
The cure

Although there isn’t 1 specific vaccination, several forms of antibiotics can combat the disease:

  1. Index-linked bonds. The government very kindly issues bonds for this purpose. These gilts are linked to inflation: the yield will be a certain % + inflation for that period. Very useful if you’re worried about inflation, as everyone should be.
  2. Foreign currency. If my domestic currency becomes worthless or partially worthless, I can combat this by holding other currencies. These will increase in value relatively as my domestic currency degrades in value.
  3. Real assets. Holding real assets lets you hold a piece of something, well, real. Actual things in real life tend to be worth something regardless of the value of your domestic currency. Examples include gold, villas in the South of France, aged Portuguese wine, Picasso pieces, etc.
  4. Cryptocurrency. These digital currencies have the benefit of being decentralised: governments and central banks can’t stick their clumsy fingers in and degrade the value. This is a supreme advantage. Yes, these currencies still have growing pains but when fiat money is going to shit they can provide some kind of protection against the shitshow.
  5. Stocks. Inflation pushes the value of stocks upwards (see Does the Stock Market Always Go Up? for more details). This is the investment Bernstein recommends in Deep Risk, in fact (2). It stands to reason that stocks probably provide at least some level of inflationary protection. Just how much, exactly, is up for debate.

It’s hard to tell to what extent each of these work (again, empirical evidence can be misleading). But recognising the problem is the first step on the road to recovery (or, in our case, protection). As soon as we understand the dangers of certain actions we can start to mitigate the risks associated with said actions. Wear a helmet whilst riding a bike. Put your seatbelt on whilst driving a car. Own assets that protect you from inflation whilst investing.


(1) The other “deep risks” he identified were deflation, confiscation (of assets) and devastation (a world war, for example). He raises some good points, particularly about the relative costs of protecting against each problem, which I had not previously considered. However, he relies too heavily on empirical analysis and does not make a strong deductive argument in my opinion.

(2) To be fair, he advises you to hold others to protect against inflation too. His point was more that stocks perform ok during high inflationary periods and perform well outside of them. Therefore, they are not subject to the same inflationary risks that bonds are for example.

What do you think?

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