12 December 2009
By Joseph Lisanti
With the economy struggling and unemployment high, inflation is likely to remain subdued for a while. But the federal government is spending a bundle of borrowed money, the value of the dollar is sinking, and commodities are surging-all of which could portend significant price increases in the future.
New York University economics professor Nouriel Roubini, speaking at a recent conference, said that he believed deflationary forces would be in control for the next year or two, but that inflation could reappear in 2011 or 2012. Roubini's forecasts have gained a large following since he correctly predicted the housing bubble and subsequent recession.
Many traditional portfolio bulwarks against inflation have already moved sharply higher. How can you protect yourself from future erosion of your standard of living? Here are some choices. If you plan to add an asset category that has soared, do so gradually.
Gold. This precious metal has risen in price as the dollar has declined, but experts say it remains a good way to preserve purchasing power. "Gold has been, historically, a very good hedge against both the US. dollar and inflation," says Jason Toussaint, managing director of the World Gold Council, an organization owned by the largest gold-mining companies.
Owning gold bullion isn't a great choice for individuals because it's expensive to store and insure. Alternatives exist among exchange-traded products that hold physical gold and issue shares representing ownership of roughly one-tenth of an ounce of the metal. SPDR Gold Shares (symbol GLD) and iShares COMEX Gold
Trust (IAU) each have an expense ratio of 0.40%. Many financial planners say only a small percentage of your portfolio should hold gold.
Commodities. Investing directly in physical commodities can be a problem for long-term investors because commodities are subject to enormous price swings. Over long periods of time, indexes tracking multiple commodities tend to produce anemic results.
It's best for small investors to invest in stocks of companies that develop natural resources and other commodities, such as oil, industrial metals and agricultural products.
No-load funds T. Rowe Price New Era (PRNEX) and Fidelity Select Materials (FSDPX) provide diversified exposure to commodities producers. New Era is up 10.9% annually over ten years, and Select Materials is up 10.9% a year over the same period.
Stocks. In periods of moderate price increases, common stocks can provide inflation security because companies can raise prices. “I always put some equities in the mix, even in a 95-year-old’s portfolio,” says Bedda D’Angelo, president of Fiduciary Solutions, a wealth-management firm in Durham, NC. D’Angelo recommends no-load mutual funds that focus on large-company value issues as a conservative equity holding.
Keep in mind, though, that severe inflation can strangle the stock market as it did in the 1970s. D'Angelo counters that people who held on to stock positions in those lean years were amply rewarded when equities soared after 1982.
Fixed income. As inflation rises, the value of traditional bonds declines. Treasury inflation-protected securities provide an adjustment to principal to make up for the purchasing power lost to inflation. But that adjustment creates taxable income each year, even though you don't get the cash until the bond matures or is sold. TIPS are best kept in tax-deferred accounts through Vanguard Inflation-Protected Securities (VIPSX) or iShares Barclays TIPS Bond (TIP).
Another approach is to buy emerging-markets bonds. Ray Mignone, a certified financial planner in Little Neck, NY, says that bonds denominated in emerging-markets currencies will gain value as the greenback falls. "And most of those [developing] countries have better balance sheets than we do," he says.
For a diversified portfolio, Mignone uses Pimco Developing Local Markets (PLMAX), which holds short-term bonds, and the intermediate-term Pimco Emerging Local Bond (PELAX). Both carry sales charges, but they are often available without loads through planners and 401 (k)s.