|
 |
|
|
Inflation, Not The Bear market, Is The Real Portfolio Destroyer |
| |
Consumer prices in March were virtually un-changed from a year earlier, as the core rate of inflation rose just 1.1 percent. You had to go back to January 1966 to find a smaller year-over-year price increase.
A savvy investor would not assume from this that inflation is dead, but rather that it is merely taking a breather. The inexorable long-term rise in prices almost surely will gain momentum at some point in the future. Investors who don’t take that threat of inflation into account when planning their portfolios may someday find themselves short of enough spending money.
Although many investors who suffered through the recent bear market are still focused on stock market volatility as a threat to their portfolios, it is inflation that is the real threat, says Kent Smetters, a risk management professor at The Wharton School.
He notes that the worst decade for stock market investing was not the Great Depression, or the recent double-bear decade, or the Panic of 1987.
The ugly 1970s
Instead, it was the 1970s, a period of double-digit inflation touched off by the OPEC oil crisis. The purchasing power of a dollar fell by 50 percent then, he says. For every additional percentage point of inflation, he says, an investor loses 20 percent of his purchasing power. And more often than not, this purchasing power erosion occurs in the background.
"Inflation lurks in the shadows," he writes. "It destroys value, gradually eroding real returns over time. It is financial death by a thousand cuts."
Unwary investors look at the numbers in their portfolios without accounting for what their dollars can buy over time, a mistake the famous economist John Maynard Keynes termed "money illusion."
What portfolio strategies should you use to combat inflation?
TIPS, not gold
A traditional answer has been gold, oil, and other commodities whose prices go up with inflation. However, Smetters and others say that although commodities are well correlated with inflation, they don’t offer enough extra re-turn to compensate for their higher risk.
Commodities are about twice as volatile as the U.S. stock market, he says.
Gold is currently a darling of the hard-money, inflation fearing crowd. Historically, however, it hasn't been a great inflation hedge.
Treasury inflation protected bonds and stocks are good bets
A dollar invested in gold at the end of 1977 would have grown to $1.84 by the end of 2009. But a dollar invested in much safer cash reserves would have grown to $1.91, while a dollar in U.S. common stocks would have hit $8.87. Smetters thinks Treasury Inflation Protected Securities (or TIPS), stocks, and corporate bonds are better bets. TIPS are unique: although they carry a fixed interest rate, their principal value is increased along with inflation, which thereby increases the interest payments over time.
Stocks, although not well correlated with inflation, have a long-term re-cord of growing faster than the inflation rate. Smetters likes emerging markets stocks especially, because they have the hedging power of stocks and allow you to diversify out of the U.S dollar.
Short-term bonds also tend to adjust their interest rates to keep up with inflation at an acceptable pace, he says.
©OSB Financial Services, INC rights reserves.Information has been obtained form sources believed to be reliable, but its accuracy and completeness and the options based thereon, are not guaranteed. Always consult your a financial adviser and prospectus before making an investment
©2009, Kelly Ruggles Web site
Kelly C. Ruggles is a fee-based financial planner located in Spokane.
Kelly C. Ruggles, President of American Reliance Group, Inc., a registered investment advisor.
Kelly Ruggles is the author of "The Financial Playbook" for Retirement
Kelly C. Ruggles does not intend to provide personalized investment advice through this publication and does not represent the strategies or services discussed are suitable for any investor. Investors should consult with their financial advisors prior to making any investment decisions
|
|
|
|
