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Investment Performance During Recent Inflation

It's been a while since I've posted because my family and I have been extremely busy lately. I will be shortly posting on the reason and announcing some big new for us personally.

But in the interim, I thought that it would be interesting and perhaps helpful to review how various investments have performed over the last two years, the period with the highest inflation the U.S. has experienced in more than 40 years. While we should be very cautious in making definitive conclusions of any sort using only 24 months of data, there are still some tentative lessons to be learned.

Historic and Recent Inflation

Following the high inflation of the 1970s and early 1980s, inflation in the U.S. was relatively low from 1983-2020, averaging 2.6%. The highest annual (i.e., calendar year) inflation rate during this period occurred in 1990, when it reached 5.4%. Many investors believed that the inflation 'beast' had been 'tamed'.

Then there was a massive increase in the money supply after the COVID-19 pandemic. The M2 money supply increased by an astounding 40% between February, 2020, and March, 2022. Since inflation is usually the result of 'too much money chasing too few goods', it's not surprising that inflation spiked. In April, 2021, the 12-month percentage change in CPI-U, the most widely used measure of inflation in the U.S., increased to 4.2%, its highest level since 2008, and increased to 9.1% by June, 2022, before beginning to decline. CPI-U in March, 2023, was 5.0%. During the 24 months from April, 2021, to March, 2023, the cumulative increase in CPI-U was 13%.

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Recent Investment Performance

U.S. stocks did not fare very well relative to inflation during the prior 24 months with an annualized real return of -5.50%. Ex-U.S. stocks performed even worse with a real return of -9.32%. In the U.S., large-caps significantly outperformed small-caps with a real return of -4.53% vs. -10.53%. Also, value stocks outperformed growth stocks; large-cap value returned -1.64% vs. -7.24% for large-cap growth, and small-cap value returned -6.40% vs. -16.39% for small-cap growth.

Real estate investment trusts (REITs) also lagged inflation significantly with a real return of -7.80%.

In response to inflation raging, the Federal Reserve increased the Fed Funds rate from .08% in February, 2022, to 4.65% by March, 2023. This led to a substantial increase in interest rates across the board, which led to the worst performance in nominal bonds seen in decades. The U.S. total bond market had a real annualized return of -10.45% during the prior 24 months. Intermediate-term Treasuries slightly outperformed corporate bonds with real returns of -10.03% and -10.85%, respectively. Given that changes in interest rates have a bigger impact on bonds with longer maturities, it's not surprising that long-term bonds performed even worse; long-term Treasuries had a real return of -14.87% during the last two years.

Readers likely know that I believe inflation-linked bonds to be a better fit for most investors than nominal bonds since investors' obligations are generally priced in inflation-adjusted dollars. While Treasury Inflation-Protected Securities (TIPS) outperformed the overall bond market during the last two years, the real return of TIPS funds was still decidedly negative at -7.39%. This was surprising to many investors, but the reason was simple: while TIPS are priced in inflation-adjusted dollars, they are still marketable bonds, which means that they will lose value when interest rates rise.

However, Series I bonds, which are issued by the U.S. Treasury directly, are not marketable bonds, so they are unaffected by rising interest rates. Even though their fixed rate (i.e., the interest rate they earn above that of inflation) was zero from May, 2020, through November, 2022, I bonds were still very popular during the last two years because they kept pace with inflation, at least on a pre-tax basis.

One asset class that performed very well during the last 24 months was commodities. The iShares commodity fund GSG had a real return of 12.42%. Gold (as measured by the fund IAU) had a real return of .42%.


The last two years have certainly proven that inflation continues to threaten investors' buying power and that ignoring it may be perilous.

Assets that are explicitly linked to inflation, such as I bonds and TIPS, performed better than similar assets priced in nominal dollars, but rising interest rates eroded the value of TIPS. Nominal bonds suffered greatly during the last two years, especially those with long maturities. The belief that 'bonds are safer than stocks' has not been supported by the events of the last two years.

Stocks had better returns than bonds but still lost value. Large-caps outperformed small-caps by a wide margin, and value stocks had substantially better returns than growth stocks. Interest rates increasing also hurt the performance of REITs.

Commodities considerably outperformed all other asset classes. Gold, while being volatile, kept pace with inflation.

In sum, tangible assets generally held up better than others, with the exception being real estate, which is negatively impacted by rising interest rates. Also, while stocks have lost value, they have outperformed nominal bonds, which was to be expected as their revenues generally increase at more-or-less the rate of inflation. Similarly, inflation-linked bonds also outperformed nominal bonds.

However, the last two years' happenings should not necessarily mean that investors should change their investment strategy. The vast majority of investors are investing for much longer time frames. But those considering making permanent changes to their strategy may wish to consider how rising inflation and interest rates may impact their investments in the future.

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