WSJ - Worst Decade in 200 Years for Inflation-Adjusted Returns

Many investors realize that stocks have been among the worst investments of the past decade. But they may not realize quite how bad the decade was, because most people forget about the effects of inflation.

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.

Despite its 2009 rebound, the Dow Jones Industrial Average today stands at just 10520.10, no higher than in 1999. And that is without counting consumer-price inflation. In 1999 dollars, the Dow is only at about 8200 and would have to rise another +28% or so to return to 1999 levels. Using today's dollars and starting at 10520.10, the Dow would have to surpass 13460 to get back to its 1999 level in real, inflation-adjusted terms.

Since the end of 1999, the Standard & Poor's 500-stock index has lost an average of -3.3% a year on an inflation-adjusted basis, compared with a +1.8% average annual gain during the 1930s when deflation afflicted the economy, according to data compiled by Charles Jones, finance professor at North Carolina State University. His data use dividend estimates for 2009 and the consumer price index for the 12 months through November.

Even the 1970s, when a bear market was coupled with inflation, wasn't as bad as the most recent period. The S&P 500 lost -1.4% after inflation during that decade.

That is especially disappointing news for investors, considering that a key goal of investing in stocks is to increase money faster than inflation.

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, noting that gold hit a record this month in nominal terms but remains far from its 1980 record in real terms. Because analysts almost never do the same with stocks, it leaves investors with an exaggerated view of their portfolios' performance over time.

"Looking at returns on a nominal basis can be very misleading," says Richard Bernstein, a former chief investment strategist at Merrill Lynch who is launching a New York money-management firm called Richard Bernstein Capital Management. He checks inflation-adjusted performance to monitor investments' real value.