The most successful investors in history know a thing or two about inflation. Of the many great insights on the topic, perhaps no single quote sums it up better than this one from Charlie Munger:

“I remember the $0.05 hamburger and a $0.40-per-hour minimum wage, so I’ve seen a tremendous amount of inflation in my lifetime.

Did it ruin the investment climate? I think not.”

The problem with inflation is that it erodes purchasing power. In simple terms, inflation means a dollar today won’t buy as much as a dollar tomorrow. However, as Munger’s career proves, there is still a tremendous amount of money to be made even when prices are rising.

In this post, we’ll look at famous quotes from the masters of investing to learn how inflation impacts businesses and how we can improve our own returns by understanding its implications.

The Basics of Inflation

What makes inflation particularly insidious is that its effects aren’t always obvious. It is a “silent” confiscation of wealth that happens over years.

Many investors fail to compare their market returns to the rate of inflation. If your portfolio grows by 8% but inflation is at 9%, you haven’t actually generated wealth—you’ve lost 1% of your purchasing power. We call the raw number the nominal return, but the number that actually matters is the real return.

The 1970s and early 1980s are perfect examples of this. While the stock market technically rose, “real” returns were so poor they rivaled the Great Depression because inflation was in the double digits. Warren Buffett adeptly pointed out this psychological trap:

“It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation or pays no income tax during years of 5 percent inflation. Either way, she is ‘taxed’ in a manner that leaves her no real income whatsoever.”

Jason Zweig, in his commentary for The Intelligent Investor, made a similar observation about the early 1980s:

“Investors were delighted to earn 11% on bank certificates of deposit (CDs) in 1980 and are bitterly disappointed to be earning only around 2% in 2003—even though they were losing money after inflation back then but are keeping up with inflation now.”

With all of that said, investors who do understand inflation’s role in the economy and stock market might still become ensnared and see their post-inflation returns reduced, if they don’t invest in ways that reduce the impact of inflation on their investments.

As Buffett’s mentor Benjamin Graham said,

“Investors feelings and reactions regarding inflation are probably more the result of the stock market action that they have recently experienced than the cause of it.”

You can imagine that the fickle minds of investors and the emotional Mr. Market can be swayed greatly by recent events—this is a well known behavioral bias and is seen commonly in the stock market.

Another great example of the way that inflation has influenced investors and the way they think and feel about the stock market was this combination of quotes by Peter Lynch:

“Investors bail out of stocks because they worry that companies can’t grow their earnings fast enough to keep up with inflation…

…You have to have faith that inflation will cool down eventually, and that recessions will thaw out.”

Those ideas form the crux of how inflation can really hurt investors by encouraging behavior which runs counter to long term investing success.

Bailing out of stocks because of fear or uncertainty is one of the worst things you can do as a long term investor!

The reality of the stock market is that it can be very volatile over the short term. This makes timing the market impossible.

But, if you hold stocks over the long term, you should get very good results.

Business Performance and Inflation

It makes sense that businesses struggle during inflationary periods. Rising prices mean rising costs for labor, raw materials, and energy. If a business cannot raise its own prices to match these costs—either because of stiff competition or a weak brand—its profit margins will get squeezed.

When profits shrink, stock prices usually follow. This is especially true for companies that were “priced for perfection” before inflation hit. However, over the very long term, stocks outperform almost all other asset classes regardless of inflation. The famous economist Irving Fisher said it best:

“In steadiness of real income, or purchasing power, a list of diversified common stocks surpasses bonds.”

Why Stocks Are the Ultimate Inflation Hedge

Why did Fisher believe stocks beat bonds? It comes down to what a stock actually is: partial ownership of a real business.

When you own a share, you own a piece of the company’s future profits. Unlike a dollar bill, the supply of shares in a successful company doesn’t usually “inflate” over time. In fact, many great companies use their cash to buy back shares, making your slice of the pie even larger.

If you own 10% of a business today, you still own 10% of that business tomorrow, whether a dollar is worth $1.00 or $0.50. Inflation can devalue a currency, but it cannot directly devalue your percentage of ownership in a productive asset.

The Best Kinds of Stocks Against Inflation

The “best” companies are those with pricing power. I recently used See’s Candies as an example of this in our newsletter:

“Warren Buffett purchased See’s Candies during the inflation-gripped 1970s. Because consumers are loyal to the brand, they eagerly absorb price increases even during economic uncertainty. See’s requires very little ‘capital expenditure’ to run, meaning it doesn’t have to spend a fortune on new factories just to keep up. It mints free cash, and because its expenses are minimal, the damage from inflation is limited.”

This “capital-light” model is the secret. If a company has to spend millions on new equipment just to stay in business, inflation will make that equipment more expensive every year. But a brand-heavy, asset-light business like See’s can raise prices without seeing its costs skyrocket at the same rate.

It is all made possible by the company’s competitive advantage, or “moat.”

The Trap of “Hard Asset” Companies

Many investors try to beat inflation by buying commodity producers or gold miners. The logic is that if gold prices go up, the miners make more money.

However, mining is capital-intensive. While their revenue might skyrocket, their expenses (fuel, heavy machinery, labor) follow right along. Often, the “inflation boost” to the top line is completely eaten away by the rising costs of production.

The Reality of Inflation

We can prepare our portfolios, but we cannot ignore the fact that inflation is a “necessary evil” of the modern economy. Warren Buffett famously compared it to a devastating tax:

“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital.”

Inflation is bigger than any one person or politician. It is a force we must live with.

Hopefully, these insights from the world’s greatest investors help you position your portfolio to not just survive inflation, but to thrive through it.