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The Quiet Danger of Non-Inflation-Adjusted Stock Returns

In today’s Wall Street Journal, E.S. Browning has written a quietly important article (gated) about the fact that stock-market returns are almost never adjusted for inflation. While most shrewd investors factor in this omission, my sense is that a great many people never think about it, and therefore significantly overestimate their investment gains.
As with most things in life, this problem is a result of misaligned incentives. As Browning deftly puts it:

Controlling for inflation takes extra work and makes stock gains look punier, so it is easy to see why stock analysts almost never do it. The media almost never do it either. But other things do get measured in real dollars. When economists report whether the economy is growing, they account for inflation. When analysts judge long-term gains in commodities such as gold or oil, they often adjust for inflation. … Because analysts almost never do the same with stocks, it leaves investors with an exaggerated view of their portfolios’ performance over time.

It isn’t so hard to find information about inflation-adjusted returns. And there are plenty of other important investment factors that are kept too quiet — returns that factor in dividend gains, for instance, and returns minus the eventual cap-gains tax. But it is a telling fact that something as basic as inflation is often left out of the investment story. Of course, it is in the interest of much of the financial-services industry to do so.
Browning highlights a money manger in Santa Fe named Garrett Thornburg, who:

… calculates what he calls “real-real” returns, adjusting the stock performance not only for inflation but also real-world drags such as taxes and fees. Nominally, a dollar invested in the stocks of the Standard & Poor’s 500-stock index at the end of 1978 had blossomed to $22.88 at the end of 2008, including dividends, a sweet gain even after the 2008 meltdown. But once estimates of inflation, taxes, and costs are removed, he figures, the investment was worth $3.76.

That said, such a return beats most alternatives. But the “real-real” value of stocks does make you appreciate how so many people got so jazzed about the spike in housing prices over the last decade: it’s exciting to see inflation working in your favor day after day.