# Stock index values in relation to inflation?

I read somewhere recently that there has been a posited "stock crash" since 2000.

The premise of the writer was that because some stock indexes - I think the Dow Jones was used - are below their peaks, they have actually crashed in reality, because of the effect of inflation.

So, while the media gets excited that an index is near "record highs", it may be that it is in fact 10-15% down since 2000, as this is the amount of inflation in this period.

This sounds sensible to me, but... is it correct? What I am not clear in is the composition and calculation of the indexes. Is there something inherent in them that adjusts for or in other way reduces the effect of inflation?

So... if an index is at 10,000 right now and we have 10% inflation in the next year, would the index need to be at 11,000 to actually remain at par?

Thanks!

You are on the right track. More formally, you are asking about the difference between nominal and real rates of return.

The nominal return is the raw or unadjusted increase. The real return is adjusted for the effects of inflation.

If an index increases from 10k to 11k, the nominal return is 10%. However, if inflation reduces your purchasing power such that you can buy the same quantity/quality of goods this eyar with 11K that you bought last year with 10k, then the real return on you money is approximately 0%, even though your nominal return is 10%.

Mathematically this is operationalized in the the Fisher equation: (1+r)(1+i)=1+R where r is the real return, i is the inflation rate and R is the nominal return. Multiplying this out gives you r+i+r*i=R. Since r*i is usually tiny- especially in the US- it is ignored. Thus, we have r+i=R. Since you always know the nominal return and an estimate of inflation, you can solve for r with r=R-i.

Since the real rate of inflation varies like the nations gas prices vary, it is impossible to accurately predict or figure gains or losses on investments, in my opinion.

I personally am very slowly selling my stock portfolio off and again slowly transferring some of the proceeds into non-taxed tangible physical Gold.

Over the last 6 years I have averaged about a 24% dollar gain in appreciation.

http://www.goldmoney.com/

It is a lot of reading but check it out, it's your future, not mine.

******************************...

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The premise of the writer was that because some stock indexes - I think the Dow Jones was used - are below their peaks, they have actually crashed in reality, because of the effect of inflation.

So, while the media gets excited that an index is near "record highs", it may be that it is in fact 10-15% down since 2000, as this is the amount of inflation in this period.

This sounds sensible to me, but... is it correct? What I am not clear in is the composition and calculation of the indexes. Is there something inherent in them that adjusts for or in other way reduces the effect of inflation?

So... if an index is at 10,000 right now and we have 10% inflation in the next year, would the index need to be at 11,000 to actually remain at par?

Thanks!

**Answer:**You are on the right track. More formally, you are asking about the difference between nominal and real rates of return.

The nominal return is the raw or unadjusted increase. The real return is adjusted for the effects of inflation.

If an index increases from 10k to 11k, the nominal return is 10%. However, if inflation reduces your purchasing power such that you can buy the same quantity/quality of goods this eyar with 11K that you bought last year with 10k, then the real return on you money is approximately 0%, even though your nominal return is 10%.

Mathematically this is operationalized in the the Fisher equation: (1+r)(1+i)=1+R where r is the real return, i is the inflation rate and R is the nominal return. Multiplying this out gives you r+i+r*i=R. Since r*i is usually tiny- especially in the US- it is ignored. Thus, we have r+i=R. Since you always know the nominal return and an estimate of inflation, you can solve for r with r=R-i.

Since the real rate of inflation varies like the nations gas prices vary, it is impossible to accurately predict or figure gains or losses on investments, in my opinion.

I personally am very slowly selling my stock portfolio off and again slowly transferring some of the proceeds into non-taxed tangible physical Gold.

Over the last 6 years I have averaged about a 24% dollar gain in appreciation.

http://www.goldmoney.com/

It is a lot of reading but check it out, it's your future, not mine.

******************************...

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