The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [23]
For better or worse, the gambling instinct is part of human nature—so it’s futile for most people even to try suppressing it. But you must confine and restrain it. That’s the single best way to make sure you will never fool yourself into confusing speculation with investment.
Chapter 2
The Investor and Inflation
Inflation, and the fight against it, has been very much in the public’s mind in recent years. The shrinkage in the purchasing power of the dollar in the past, and particularly the fear (or hope by speculators) of a serious further decline in the future, has greatly influenced the thinking of Wall Street. It is clear that those with a fixed dollar income will suffer when the cost of living advances, and the same applies to a fixed amount of dollar principal. Holders of stocks, on the other hand, have the possibility that a loss of the dollar’s purchasing power may be offset by advances in their dividends and the prices of their shares.
On the basis of these undeniable facts many financial authorities have concluded that (1) bonds are an inherently undesirable form of investment, and (2) consequently, common stocks are by their very nature more desirable investments than bonds. We have heard of charitable institutions being advised that their portfolios should consist 100% of stocks and zero percent of bonds.* This is quite a reversal from the earlier days when trust investments were restricted by law to high-grade bonds (and a few choice preferred stocks).
Our readers must have enough intelligence to recognize that even high-quality stocks cannot be a better purchase than bonds under all conditions—i.e., regardless of how high the stock market may be and how low the current dividend return compared with the rates available on bonds. A statement of this kind would be as absurd as was the contrary one—too often heard years ago—that any bond is safer than any stock. In this chapter we shall try to apply various measurements to the inflation factor, in order to reach some conclusions as to the extent to which the investor may wisely be influenced by expectations regarding future rises in the price level.
In this matter, as in so many others in finance, we must base our views of future policy on a knowledge of past experience. Is inflation something new for this country, at least in the serious form it has taken since 1965? If we have seen comparable (or worse) inflations in living experience, what lessons can be learned from them in confronting the inflation of today? Let us start with Table 2-1, a condensed historical tabulation that contains much information about changes in the general price level and concomitant changes in the earnings and market value of common stocks. Our figures will begin with 1915, and thus cover 55 years, presented at five-year intervals. (We use 1946 instead of 1945 to avoid the last year of wartime price controls.)
The first thing we notice is that we have had inflation in the past—lots of it. The largest five-year dose was between 1915 and 1920, when the cost of living nearly doubled. This compares with the advance of 15% between 1965 and 1970. In between, we have had three periods of declining prices and then six of advances at varying rates, some rather small. On this showing, the investor should clearly allow for the probability of continuing or recurrent inflation to come.
Can we tell what the rate of inflation is likely to be? No clear answer is suggested by our table; it shows variations of all sorts. It would seem sensible, however, to take our cue from the rather consistent record of the past 20 years. The average annual rise in the consumer price level for this period has been 2.5%; that