Measuring Real-World Inflation versus Investing Returns

Raymond James’ Jeff Saut made reference earlier this week to a WSJ article from February of this year; I adapted part of that in my market comments today.

Here’s the WSJ excerpt:

“If you have a house that you bought in 1970 for $100,000 and sold it for
$400,000 today, the gain was just inflation – you made nothing. In fact, you may
have lost money if you paid a 6% sales commission.” Also adding insult to the
inflation-injury has been the massive decline in the purchasing power of the
dollar since 1970."

-WSJ, Quoting Garrett Thornburg of Thornburg Investment Management

That number seemed a little light to me — so I went to the BLS Inflation Calculator. It turns out that if you bought a home for $100,000 in 1970, it is the equivalent of $514,948.50 in 2006 dollars. 

Still, that’s a pretty astonishing number, and it makes Thornburg’s point that you have to consider inflation in your expectations for performance. After all, its the real (not nominal) numbers that matter most.



BLS Inflation Calculator

For Long-Term Investing Plan, Measure Real-World Return
WALL STREET JOURNAL, February 6, 2006; Page C1

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What's been said:

Discussions found on the web:
  1. Todd commented on May 2


    Wouldn’t you agree that the BLS calculator you link to vastly UNDERSTATES inflation – particularly the way gov data has been manipulated over the past 20 years?

    Would love your take on how much higher this should be. How about a BR Inflation calculator?

  2. Nona commented on May 2

    Don’t forget the carrying costs for a home: repairs, taxes, etc., etc., etc.

    Add those figures to the commission costs.

  3. Jonathan commented on May 2

    What happens if you factor in leverage? Buy a house for $100K in 1970 with $20K down. Sell it for $400K. Pay off the mortgage and you’ve made an 8% compound return, a nice gain over inflation. The only “bad” decision home owners made was not to leverage themselves. And if the home owners refinanced as rates fell, using cheap inflated dollars to service their mortgage, so much the better.

  4. royce commented on May 2

    This is the mutual fund industry’s secret marketing tool. They love showing you the nominal return over the percentages.

  5. chuck commented on May 2

    Some thing about these numbers that don’t tell the whole story, it implies that home
    ownership is only keeping up with inflation.
    A house I bought in Southern California for $25,000 in 1970 would now sell for $400,000,
    and for $100,000, [if I would have had it!], would have bought a house in an exclusive
    area that would now sell for well over a $1,000,000

  6. jkw commented on May 2

    Going from $1 to $46 in 70 years is pretty good. That’s an average annualized return of 5.46% (compared to the nominal return of 11.92%).

    It would be more interesting to see the return broken down year-by-year. How much variation is there in nominal stock index returns? How bad do secular bear markets get in real returns?

  7. Robert Cote commented on May 2

    Don’t forget the value of living someplace for 36 years for free or the fact that you are selling an item that is 36 years older at the time of resale for more than you paid for it.

  8. semper fubar commented on May 2

    Makes you wonder if most people ever make any money. On anything.

    In the end, we’re all dead. In the meantime, I guess most of us are just barely keeping up.

  9. kevinmr commented on May 2

    I calculate a 2.59% real return using the median home value and annual CPI data.

  10. toddZ commented on May 2

    WOW! What a great article.

  11. trader75 commented on May 2

    Also consider that, while hedonic adjustments may be tools of satan in the short run, they have some intellectual value in the long run.

    When talking about real ‘stuff’ that consumers spend mucho dinero on–cars, houses, big screen TVs, outpatient surgery–there is a whopping difference in quality between 1970 and today.

    Over a long enough time horizon, technology really does change the game, or at least alter it significantly. They say land is the best investment because they aren’t making any more of it–but look far enough down the road and even that might not be true.

  12. kennycan commented on May 3

    Even land is subject to some inexorable forces. Think skyscrapers and utilization of available land. Now commercial enterprises can put tens of thousands of people to work on land that used to support only a few thousand. Like NYC at the turn of the century and its 10 story skyscrapers that now stand 50-100 stories and are more efficient internally as well.

    How about reclaimed arid dessert or harbor front. Hong Kong makes new land all the time. Just fills in their harbor somewhere!!

    Somehow I have a nagging suspicion that hedonic adjustment is double counting though. Aren’t the technological efficiencies already captured in lower prices somewhere already? Like transport costs are down for goods because trucks get better mileage. Also, I have doubts about how they quantify the quality adjustment. Could they be overestimating the quality when they put a number on it?

  13. Jonathan commented on May 3

    And don’t forget the tax advantage of housing. You need to multiply the return on the housing investment by 117% (= 1/(1 – cap gain tax rate)) to adjust for the fact that gains (of $500K) are tax free vs. a 15% tax on capital gains. To say nothing of the deductions on mortgage interest, the emotional benefit of owning vs. renting (ok…that is subject to debate), and the (typically) lower cost of owning vs. renting. A one-dimensional model is just that, one dimensional.

  14. Mary commented on Sep 20

    This is a specious comparison. A $100,000 house was 3-5 times the average cost in 1970, even in California.

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