I tried to be truthful but then I began to think about what my dad would want to hear in response. It made him sad when I responded that his mom had passed, so I would try to subtly shift the conversation when I could. The suggestion above about talking in a positive way about whatever subject they raise is great advice. My dad used to see people that werent there, and hes talk about them... at first we told him they were only in his mind, and that would end the convo, but as time went on I would ask him if they were nice, etc, and he would be able to talk about that as if it were a real convo we were having, and that convo was worth more than the dead-end of the truth which was not his truth. It reminded me of A Beautiful Mind, when he was torn between what he saw and what he was told.
In other cases, he might ask something about, e.g., science that he was trying to recall, and Id tell the truth about that even if he was wrong, since he seemed to be able to absorb that back into his world-view and continue with whatever hed been thinking about.
The most helpful way Ive heard the inner experience described is that the journey of dementia/AD is like a bus... when they first board, they know what town theyre in, what street theyre on and where theyre going, as well as knowing many of the people on the bus and outside on the street. As the bus goes along, they recognize fewer and fewer people, cant recall where they are or where theyre going, and so forth... its easy to understand how challenging it must be as touch points are lost along the way. So, aside from healthcare, comforting by the loved ones is job one.
Very best of luck and strength to you on your own hard journey.