There is an old saying: A rising tide lifts all ships. A rising tide can also drown them out. And as signs of economic recovery appear on the horizon, there is a real possibility that inflation will come with the tide. Why worry about inflation? Well, inflation is the worst nightmare of an investor. For retired individuals living on a fixed income, this can ruin one’s savings and lifestyle. As a bondholder or CD holder, the purchasing power of regular interest income is hit. As a stock investor, stock prices can suffer as profit margins and gains on your assets are offset by higher costs for inputs such as energy, precious metals and labor.
Right now, Wall Street is in a good mood. For the just-concluded quarter, the Dow gained about 14%, the S&P rose 14.5% and the NASDAQ rose 15%. In fact the last time the Dow saw such a big quarterly rise was again in the fourth quarter of 1998 when it rose more than 17% while dot-com bubbles were forming. This quarter’s rally continued a trajectory that began in mid-March 2009. It was driven primarily by headlights at the end of the tunnel. A variety of positive statements by Federal Reserve Chairman Ben Bernanke contributed to a more optimistic outlook. Residential real estate sales continued to return mainly driven by a first-time buyer tax credit. Corporate profits have increased.
The popular “cash for clunker” program boosted vehicle sales and by some measures consumer spending increased in a limited way even without impact from vehicle sales. Despite the rally on Wall Street, Main Street is still hurting: unemployment continues to rise, business and personal bankruptcies have risen, bank failures are at their highest and the dollar continues to weaken fears of street inflation. Signs of higher inflation in the future are on the radar screen: All the economic incentives of the government here and abroad accompanied by rising public debt; The Fed’s projected end of a program by the Fed in March 2010 that is likely to lead to higher mortgage rates; a Fed interest rate policy, which has nowhere to go, but the hassles that foreign governments and investors may not want to continue with their current pace of supporting our debt habit. So how do you position yourself to take advantage of any wave return method?
Now, more than ever, it is it is important to have a risk-controlled approach to investing.
This focuses on an age-based allocation that involves exposure to multiple assets. That is why we will continue to manage portfolios with an allocation of bonds and fixed income, but there are ways to hedge against the impact of inflation and still allow growth.
1.) Include capital paying dividend: Using mutual funds or ETFs that focus on dividend-paying stocks will help increase revenue as well as returns. Shares that pay dividends have an average close to an annual return of 10% compared to a total return of less than half that for shares that rely solely on capital appreciation. Better yet, consider equity stocks or ETFs that focus on stocks that have a record dividend growth
2.) Stay short: By owning bonds, ETFs, or bond bonds that have a shorter average maturity, you reduce the risk of being trapped in less valuable bonds when higher inflation raises interest rates in the future.
3.) Protect your bets with inflation-linked bonds: Fixed rate bonds do not offer protection against inflation. A bond that has changes related to an inflation index (such as the Consumer Price Index) such as TIPS issued by the US government or TIP-owned ETFs (such as the iShares TIPS Bond ETF – TIP symbol) provides an opportunity for a bond investor to taken periodically offset by high inflation.
4.) Navigate your boat with Floating Order Notes: These medium-term bonds are issued by corporations and restore their interest rates every three or six months. So if inflation heats up, the interest rate offered is likely to rise. Yields are generally higher than those offered by government bonds usually due to the issuer’s higher credit risk.
5.) Add Junk to Trunk: High-interest bonds are issued by companies that have experienced lower levels – just like homeowners with mortgages. Yields are set higher than most other bonds due to higher risk. However, as inflation heats up with a growing economy, the prospects of firms releasing waste improve and the perceived risk of default may decline. So as the yield gap narrows between these “junk” bonds and Treasuries, these bonds provide a “pop” for investors.
6.) Own gold and other goods: Whether as a repository of value or protection 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 directly related to physical gold. The tax treatment of precious metals is higher because of its status as “collectible”, but this is a small price to pay for an inflation hedge. And because demand for goods generally grows with an expanding economy or a weakened dollar (in the specific case of oil), owning the funds that hold these goods will help protect against the inflationary impact of an expanding economy.