Inflation. It has been called the silent killer. The slow and steady erosion of purchasing power can wreck retirements and put long savings plans in jeopardy.
But lately, inflation hasn’t exactly been a “killer.” It has been more of a fly buzzing around investor’s heads. Thanks to the Great Recession, credit crisis, falling commodity prices, low interest rates and relative anemic growth, it has been pretty nonexistent over the last couple of years. Investors have basically forgotten about it.
That ignorance makes inflation’s potential harsh effects an even greater threat.
And that’s because while most investors have been ignoring it, inflation is starting to come back — hard. Annual inflation — as measured by the Consumer Price Index (CPI) — is now running at 1%. That’s a marked improvement over last two years. Meanwhile, core U.S. inflation is higher, at 2.2% on an annual basis. We’re finally starting to see some real inflationary fireworks and potential return to the normal long-term 3.79% average rate.
io. Adding a dose of inflationary protection is easy, and now could be the best time to buy the insurance. Here are three ways to protect your portfolio.
Ways to Fight Off Rising Inflation: Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
A classic play for investors to fight inflation has been Treasury Inflation-Protected Securities or TIPS. TIPS are bonds that provide investors a fixed yield plus an “extra boost” of continually ongoing adjustments designed to offset inflation. With them, you’re always “beating” inflation by a set amount.
The problem is, just like all bonds, TIPS are subject to the whims of the Federal Reserve and interest rates. Rising rates will crush their prices.
Which is why the exchange-traded fund Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) could be a great choice.
VTIP bets on the shorter end of the TIPS maturity and duration spectrum — in this case, TIPS that have maturities of less than five years. In general, shorter-term bonds have less interest rate sensitivity and won’t see their prices fall by that much. That makes VTIP’s holdings — currently 17 different short-term TIPs — a better play on inflation. The Fed WILL raise rates when inflation gets high enough.
Since the fund’s inception back in 2012, returns have been roughly zero. But that only highlights how much investors have forgotten about inflationary protect assets. As inflation rises, so too will VTIP.
As a Vanguard-sponsored fund, VTIP is dirt-cheap to own. Expenses for the ETF run at just 0.08%, or $8 per $10,000 invested.
Ways to Fight Off Rising Inflation: PowerShares DB Commodity Tracking ETF (DBC)
When it comes to fighting inflation, one of the best ways to do so is with commodities.
Correlations for natural resources and consumer prices pretty much move in lock-step. When comparing a basket of commodities to the Consumer Price index, commodities recognized a 0.76 correlation to the CPI changes from 1997 to 2015. TIPS only had a correlation of 0.20 during that time.
The beauty is that this correlation pretty much holds for all markets across the world, not just the U.S. Commodities are a great way to reflect local-market price indexes.
With that in mind, the PowerShares DB Commodity Tracking ETF (DBC) could make a powerful tool.
DBC tracks futures contracts on 14 of the most heavily traded physical commodities in the world. That includes natural resources like oil, corn, copper and gold. Basically, all the most important building blocks of modern society. The key to DBC is that it uses an Optimum Yield indexing strategy that allows the ETF “roll” its futures without the worries of contango or backwardation.
The ETF is also a total-return commodity ETF, meaning that investors get the gains from its holdings of U.S. Treasury and money market securities.
The combination has allowed DBC to outperform many of its commodity fund rivals over the years.
Expenses for DBC run at just 0.89%.
Ways to Fight Off Rising Inflation: iShares Core Dividend Growth ETF (DGRO)
Stocks are also a great way for investors to fight inflation. But not just any stocks will do.
In this case, the best inflation fighters are those stocks that consistently raise their dividends. That’s because those firms that raise their dividends typically do so at much faster rates than the rates of inflation.
In fact, the average dividend growth rate for the S&P 500 since the 1960s has been 5.4%. Inflation in that time has averaged just 4.1%.
The iShares Core Dividend Growth ETF (DGRO) tracks a basket of U.S. stocks that have grown their payouts each and every year. However, the Morningstar U.S. Dividend Growth Index isn’t just about a rising yield, it is about the sustainability of that dividend growth over the long haul. DGRO will apply various screens in order to kick out those with poor cash flows, super high debts and other not-so-stellar financial metrics.
Also great news is DGRO’s super-cheap 0.12% expense ratio.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.