Running out of inflation hedges
With inflation a recent worry of the Federal Reserve Board, should you be scared too?
And if you are spooked about inflation, is there anything you can do about it?
Historically, investors have relied on a variety of so-called inflation hedges, including real assets like gold and real estate, to safeguard against the threat of rising consumer prices. But the problem facing today's investors is that most of these traditional hedges have already enjoyed breathtaking rallies.
"Every natural inflation hedge you can think of has already been priced pretty richly," says Jim Shambo, a financial adviser in Colorado Springs, Colo. And as a result, it may be a bit risky for investors to buy them right now.
Real estate, for example, has peaked, and prices on existing single-family homes are beginning to slip nationwide. Gold recently hit a quarter-century high of more than $700 an ounce, but it's already starting to lose some of its luster.
Even newfangled inflation-indexed investments like Treasury Inflation Protected Securities, or TIPS, have started to top out. As long-term interest rates have ticked up lately, the average TIPS bond fund has lost around 2 percent over the past year.
So what's an inflation-wary investor to do?
First, take a deep breath. However frightening inflation may be, we are not experiencing " '70s style inflation," says Shambo. Indeed, the consumer price index, a key gauge of retail inflation, is up around 3.5 percent over the past year. That's a far cry from the double-digit increases in inflation in the late 1970s.
Also, keep in mind that you've probably already hedged some of your bets without even realizing it. For example, around two thirds of American households own their homes. Even if you don't consider your house as part of your investment portfolio, it has already helped hedge your family against rising prices.
Moreover, the average stock mutual fund currently invests more than 20 percent of its assets in industrial material and energy-related stocks, according to the fund tracker Morningstar. Since these are shares of companies that thrive when commodities are soaring, the typical domestic equity fund gives investors a decent hedge against inflation.
If you don't think that's sufficient, consider the following strategies:
- Invest in high-quality, blue-chip stocks. "The long-term traditional way to beat inflation is through the stock market," says New Jersey financial planner Paul Westbrook. The only problem is, if inflation becomes a major impediment to economic growth, the stock market will most likely suffer too. One way to hedge your bets is to stick with shares of big, blue-chip companies, which by virtue of their size have more pricing power than small companies. Moreover, because they've been beaten down and overlooked in recent years, large blue-chip stocks have the least room to fall should inflation threaten the equity market.
- Buy individual TIPS bonds. Many investors own TIPS through mutual funds, which offer ease of use and instant diversification. But the problem with bond funds, as opposed to individual bonds, is that funds have no official maturity date. As a result, TIPS funds can lose money depending on when you choose to sell. However, if you own individual TIPS bonds and hold them to maturity (at which point you'll recoup your original investment) you don't have to worry about short-term volatility. The Treasury Department currently allows individuals to purchase five-, 10-, and 20-year TIPS bonds directly through its website. Shambo recommends sticking with five-year TIPS, as longer-term bonds aren't paying sufficient yields to compensate for their greater risks.
- Consider natural-resources funds. While it's difficult to understand why gold prices have soared as much as they have, it's easy to understand why oil prices have shot higher. Demand for oil is strong, and supplies are limited. And the strength of the global economy–coupled with the difficulties of constructing new refineries–leads many market watchers to believe energy prices will remain high for some time. "This is not a temporary situation," says Bohemia, N.Y., financial planner Ron Roge. "So any investment in this area will probably give you a bit of a hedge against inflation."