by Jeff Reeves | October 4, 2013 7:00 am
Inflation has admittedly been a non-issue for the past few years.
The annualized inflation rate, as measured by the Consumer Price Index, has been less than 3% since January 2012 and hasn’t topped 2% since October 2012. And personal consumption expenditures — a separate measure of inflation — actually just turned negative.
But given the threat of another credit downgrade for U.S. government debt amid the looming debt ceiling debacle and given the super-loose monetary policy at the Federal Reserve, how long can we fend off the inflation monster?
Many investors aren’t willing to wait until inflation has started to ramp back up before they pivot their portfolio into inflation-proof assets.
So if you’re worried about inflation as we approach 2014, consider the following investments:
In this low-interest-rate environment, investors can preserve their capital in low-risk bonds that yield only about 2% because that’s less than the rate of inflation.
But if inflation starts to creep up to a 3% annual pace or more, then even the interest you’re getting on your bond investments won’t be enough to keep your nest egg intact. The balance of your account might remain stable or modestly growing, but inflation will actually erode your purchasing power.
An alternative, then, is to invest in bonds that are benchmarked to inflation — Treasury Inflation Protected Securities, or TIPS.
TIPS payments are directly linked to the Consumer Price Index, so if this measure of inflation rises, you will get a bigger payout from your investments.
Interested investors can buy individual TIPS bonds from the government via Treasury Direct, or you can invest in a more diversified fund of these securities, such as the Vanguard Inflation-Protected Securities Fund (VIPSX) or the SPDR Barclays TIPS ETF (IPE).
But be warned that TIPS are not risk-free — particularly if consumer prices remain stable like they have been. If inflation doesn’t rise, you could be locked into a rather pathetic rate of return in these bonds that lags other low-risk alternatives like investment-grade government and corporate bonds.
Consider that in 2012, expectations for inflation were so high that the Treasury sold $15 billion of TIPS at a negative rate of -0.637%! Investors expected inflation to soar, and that this negative yield would be quickly moved much higher … but given the meager pace of inflation, these investors haven’t seen anything to show for their investment.
Gold has gotten a bad rap in 2013, with the precious metal off more than 20% on the year. The declines have been due in part to speculators and sentiment, but also because the rate of inflation has been so low — and inflation is one of the biggest factors that pushes up gold prices.
If you expect big inflation down the road, hiding out in gold might be a decent option. Consider that as the U.S. suffered double digit inflation from 1979 to 1981, gold prices soared. Specifically, the precious metal went from under $230 in January 1979 to around $550 in January 1981 — with a peak of more than $850!
If you’re interested in playing gold, a physical investment in coins or bars is the most direct way. However, a number of funds including the SPDR Gold Shares (GLD) and iShares Gold Trust (IAU) allow investors to play gold bullion prices directly without the hassle of buying the metal, storing it and then trying to sell physical gold when they want to liquidate their investment.
Of course, gold investors need to remember that when inflation loses steam, so does gold — as we’ve seen with the precious metal’s fall from grace lately. It’s also worth noting that some critics say speculators trading “paper gold” via securitized funds like GLD have opened the door to greater volatility and perhaps even manipulation of the market.
So keep in mind that while gold might be a faithful hedge on inflation, that doesn’t mean you can’t lose big money if gold prices fall based on market conditions.
As gold shows, holding a tangible investment when inflation is afoot could be your best strategy. However, this approach is not limited to precious metals.
In fact, real estate could be a great investment in an inflationary environment because if all prices are rising, then rents and overall property values are rising, too.
Most retirement investors aren’t real estate speculators, of course, so it’s unrealistic for everyone to go out and buy a few houses nearby and rent them out. However, investors still have options to take this approach via publicly traded rental companies or diversified funds.
Real estate investment trusts, or REITs, are a special class of corporation that focuses on large real estate holdings. There are timber REITs like Rayonier (RYN) that own swaths of forest and sell the trees for wood and pulp, there are healthcare REITs like Senior Housing Trust (SNH) that owns elder care and senior living properties, and there are commercial REITs like Simon Property Group (SPG) that manage retail locations and malls.
As property values and rental rates rise, so do REITs. And best of all, their special tax designation mandates that 90% of taxable income is returned to shareholders via big dividends. Senior Housing Trust, for instance, yields over 6% annually at current levels!
If you’re not comfortable picking individual REIT investments, consider a diversified fund like the Vanguard REIT ETF (VNQ), SPDR Dow Jones REIT ETF (RWR) or the iShares U.S. Real Estate ETF (IYR) that hold a variety of real estate investment trusts to increase your diversification and lower your risk.
Just remember that the underlying businesses do matter, and that these are stocks as much as real estate plays. Even if inflation picks up, a bad balance sheet for your REITs could result in you losing money anyway.
Real assets are a common theme among inflation-fighting strategies, and commodities are another option. Any kind of raw material from steel to soybeans to cotton is considered a commodity, and in an inflationary environment, these goods naturally see their values rise, too.
Of course, trading commodities is a sophisticated game that involves a lot of research. Consider that corn prices just touched a three-year low thanks to a combination of a bumper crop boosting production, less demand for ethanol amid cheap gasoline prices and other factors. Following and anticipating trends in commodities can be complicated and difficult, and even if you pull that off, actually trading commodity futures via a brokerage account can result in high fees.
An alternative, then, is to consider asset-backed funds that are based on commodity prices but trade like typical stocks and ETFs.
There’s the United States Oil Fund (USO), which is benchmarked to commodity futures relating to crude oil. There’s the Teucrium Corn Fund (CORN) and the Teucrium Sugar Fund (CANE), which both invest in commodity pools relating to the underlying crops. And with each passing day, more and more commodity-backed ETFs are finding their way to the market.
But keep in mind that while inflation may lift prices longer-term, prices of these raw commodities can be quite volatile in the interim, and factors beyond inflation can affect your investment.
If you really have a lack of faith in the U.S. government’s ability to keep the dollar’s purchasing power intact, a simple solution is to look overseas and park your cash in foreign currencies.
Trading forex has become much easier thanks to technological improvements, but be warned that dabbling in foreign currencies can mean a lot of volatility, thanks to an endless flow of geopolitical news and policy actions that threaten to change the game in a hurry.
Oh, and if you want to trade a currency across the world, that might mean doing so at 2 a.m.
However, investors who aren’t concerned with day-trading forex have a host of options available to them in the funds space. Nearly every major currency has an exchange-traded product associated with it. A short list includes the CurrencyShares Swiss Franc Trust (FXF), the WisdomTree Chinese Yuan Fund (CYB) and the Market Vectors Indian Rupee/USD ETN (INR).
Of course, while the U.S. dollar faces specific pressures thanks to central bank policies and economic headwinds, each of these nations has troubles of its own. Remember, despite a general sense that the U.S. is struggling, it has enjoyed a very strong currency in the past few years.
So if you trade forex — even with one of these exchange-traded products, just remember that it’s not as simple as picking a dollar alternative to beat inflation.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.
Source URL: http://investorplace.com/2013/10/5-ways-to-inflation-proof-your-portfolio/
Short URL: http://invstplc.com/1banngS
Copyright ©2014 InvestorPlace Media, LLC. All rights reserved. 700 Indian Springs Drive, Lancaster, PA 17601.