There is an old expression: lifting lifts all boats. The rising tide can also overwhelm them. And as signs of economic improvement appear on the horizon, there is a real likelihood of inflation along with the wave. Why worry about inflation? Well, inflation is an investor’s worst nightmare. For retirees living on a fixed income, this can ruin savings and lifestyle. As a bondholder or CD holder, the purchasing power of regular interest income gets hit. As a stock investor, stock prices can suffer because the profit margin and earnings of your stocks are affected by higher costs for materials such as energy, precious metals and labor.
There is a good mood on Wall Street now. Over the just-ended quarter, the Dow gained about 14%, the S&P increased 14.5% and the NASDAQ grew 15%. In fact, the last time the Dow saw such a big quarterly surge was back in the fourth quarter of 1998, when it grew by more than 17% in the formation of dot-com bubbles. The march this quarter continued the trajectory that began in mid-March 2009. Mostly it happened through flashes of light at the end of the tunnel. Numerous positive statements by Federal Reserve Chairman Ben Bernanke have contributed to a more optimistic view. The sale of residential real estate continued to return mainly due to the initial tax credit for home buyers. The corporation’s profits increased.
The popular “cash” program has pushed for car sales, and by some measures consumer spending has increased slightly even without the impact of car sales. Despite the rally on Wall Street, Main Street continues to hurt: unemployment continues to rise, bankruptcies of businesses and personal banks have increased, bank failures are at their highest, and the dollar continues to weaken, fearing inflation. Signs of rising inflation in the future appear on the radar screen: all government economic incentives here and abroad combined with rising public debt; the Fed’s projected completion of the program in March 2010, which is likely to lead to higher mortgage rates; the Fed’s interest rate policy has nowhere to go, moreover, and rumors that foreign governments and investors may not want to continue to maintain our debt habit. So how do you post before making a profit in either direction?
Now, more than ever, it is so it is important to have a risk-controlled approach to investing.
This focuses on an age distribution that includes exposure to multiple assets. That’s why we will continue to manage portfolios with bond allocations and fixed income, but there are ways to protect against the effects of inflation while ensuring growth.
1.) Include shares that pay dividends: Using either mutual funds or ETFs that target dividend-paying stocks will help increase income as well as profits. Shares that pay dividends average about 10% of annual returns compared to a total return of less than half of shares that rely solely on capital increases. Better yet, consider mutual fund shares or ETFs that focus on stocks that have recorded dividend growth
2.) Stay short: By owning bonds, ETFs or mutual funds that have a shorter average maturity, you reduce the risk of falling into less valuable bonds when higher inflation pushes future interest rates.
3.) Hedge your rates with inflation-linked bonds: Fixed rate bonds do not provide protection against inflation. Bonds that have changes related to the inflation index (for example, the consumer price index), such as TIPS issued by the US government, or ETFs that hold TIPS (for example, iShares TIPS Bond ETF – symbol TIP), allows the investor to bond periodically getting offset by higher inflation.
4.) Sail on a boat with floating rate notes: These medium-term bills are issued by corporations and lower interest rates every three to six months. Thus, if inflation heats up, the proposed interest rate is likely to increase. Yields are generally higher than those offered by government bonds, usually due to the issuer’s higher credit risk.
5.) Add garbage to the highway: High-yield loans are issued by companies that have suffered a low valuation – such as homeowners with reduced loans who receive a mortgage. Yields are set higher than most other bonds, due to higher risk. However, as inflation heats up as the economy grows, the prospects of garbage firms improve, and the perceived risk of default may decrease. As the yield gap narrows between these “junk” bonds and the Treasury, these bonds offer “pop” investors.
6.) Own gold and other goods: Whether they are a storehouse of value or a hedge against inflation, precious metals have a long history with investors seeking protection from inflation. It is usually best to focus on owning physical gold or an ETF that is tied directly to physical gold. The tax treatment of precious metals is higher because of its “collectible” status, but it is a small price to pay for some protection against inflation. And as demand for goods in general increases with the growth of the economy or the weakening of the dollar (particularly with oil), owning funds containing these goods will help insure against the inflationary effects of a growing economy.