Friday, December 10, 2010

Worried about inflation? Consider these investments

A 1-kilo gold bar on display along with gold coins at Stack's Rare Coins on New York City's 57th Street.
A 1-kilo gold bar on display along with gold coins at Stack's Rare Coins on New York City's 57th Street.

If you're worried about inflation rearing its ugly head next year, you should probably worry about more likely catastrophes, such as being eaten by bees. Looking out a bit further — say, 2013 — inflation may become a worry. But not before then.
Still, it's good to be prepared, and if you think soaring prices may smack your portfolio, build one devoted to whipping inflation eventually.
Inflation is a persistent increase in prices, and it has been deader than Marley's ghost. The consumer price index, the government's main measure of inflation, rose 1.2% in the 12 months ended in October. Core inflation — the CPI minus food and energy — was just 0.6%.
Nevertheless, people are worried about future inflation. The main reason for concern is massive government borrowing. The nation currently owes $9.3 trillion to its creditors and is adding to that amount every day. That borrowing will eventually weaken the value of the dollar, they reason, which, in turn, is inflationary: A falling dollar makes imports more expensive.
At the moment, however, there isn't a handy replacement currency. Problems in GreeceIrelandPortugalSpain and Italyhaven't endeared the euro to most investors. "It's tough to collapse a currency against a currency that's in a financial crisis," says Richard Hoey, chief economist for BNY Mellon.
Others worry about monetary policy. To keep the economy afloat, the Federal Reserve has been buying Treasury securities, a strategy called quantitative easing. By doing so, it's increasing the money available to spend and lend. And by making money cheap, companies and individuals can refinance their debt at lower rates.
The worry: Sooner or later, banks will start lending extravagantly, fueling a huge boom in the economy. As demand outstrips supply, companies will start raising prices, which, by definition, is inflation.
The problem with this theory, at least at the moment, is that no one wants to borrow because the economy is so weak. Factories have plenty of slack capacity, so companies aren't in any rush to build new ones. And to spark a true inflation bubble, you need low unemployment: Prices can't rise unless people have the money to buy those things. Currently, unemployment is at 9.8%; it may take years to get unemployment back below 5%.
Could inflation come roaring back for any of these reasons? Sure. But probably not soon.
If the nation doesn't get a grip on its debt, or if the Federal Reserve doesn't tighten monetary policy in time, inflation could — eventually — become a problem. If you want to start building an anti-inflation portfolio, consider these:
Dividend-paying stocks. Most companies would welcome a chance to raise prices. When they can, dividend-paying companies will be able to increase their dividends.
One good place to look for dividend-paying stocks is Standard & Poor's Dividend Aristocrats. These companies have raised their dividends every year for at least 25 years. You can find the full list
High-quality dividend-paying stocks are the usual hunting grounds for equity-income funds.
Gold. Investors often go for gold when they lose faith in paper currency. But it's no panacea: Gold lost value steadily through the 1980s and 1990s, while inflation marched on. If you buy now, you'll be buying close to an all-time high.
The most convenient way to buy gold is through an exchange traded fund that buys the physical metal. The largest is SPDR Gold Shares (GLD).
TIPS. Treasury Inflation-Protected Securities, or TIPS, increase in value along with the consumer price index. Like all bonds, TIPS give you regular interest payments. But the government adds to the bond's principal according to changes in the CPI. Your interest payment is then calculated on the increased amount. As a bonus, TIPS returns are based on the CPI-all items index, which includes energy, so they offer modest protection against oil shocks. You can buy TIPS from the government at no cost, via Treasury
Real estate. If you own a house, you'd probably welcome a whiff of inflation. Real estate tends to do well when there is at least a modest rate of inflation. If you want to add to your real estate holdings, consider real estate investment trusts, which invest in commercial real estate. Two real estate funds to consider: Cohen & Steers Realty (CSRSX) or Vanguard REIT Index EFT (VNQ).
Truly horrible inflation, such as in the 1970s, isn't particularly good for any type of investment. Interest rates rise in an inflationary environment, challenging every type of investment but cash and gold. If inflation rises from low to normal — about 2% — the above investments should fare well.


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