If you feel like your money isn’t going as far lately, it’s not your imagination. According to the data obtained from the Federal Reserve, 2014 has been a banner year for inflation. While still only slightly higher than historical norms, things just feel more expensive. The numbers also leave out food and gasoline, so if you eat or drive, the inflationary bite (yes, that pun was intentional) feels even harder.
The predictions that I’ve been reading for years suggesting runaway inflation is just around the corner have, at least so far, been totally wrong. The flaw in that thinking is that inflation has to be catastrophic to do damage — and that’s not the case at all. The Fed’s comfort level for inflation is 2%, which doesn’t sound like much until you think about $100 in your zero-interest checking account being worth $98 dollars after just one year, $96.04 after two years and $94.12 the year after. Inflation is a relentless enemy that sucks value from your cash savings. Robert Kiyosaki says savers are losers and, in many ways, he’s exactly right.
Whether you believe crippling, runaway inflation is still coming — and that could certainly happen— or are just tired of the drip, drip, drip of the 2% chisel, there are ways to hedge against inflation.
Inflation Indexed Bonds (TIPS)
Treasury Inflation-Protected Securities, or TIPS, traditionally pay less interest than other government bonds, but the principal and interest are adjusted to keep pace with inflation. The downside is the principal is also adjusted for deflation as measured by the CPI, though the value will never fall below the original principal.
Hard assets include commodities, like gold and silver, but can stretch to include collectibles. Commodities, at least as an asset class, maintain relative value to the purchasing power of currency, which is affected by both inflation and monetary policy. Hard assets, like gold and silver coins, have the added advantage of providing a hedge against currency valuations.
Some people consider real estate a hard asset, but I put it in a separate class because you can’t make improvements to your gold and silver, but can make improvements to property. It’s important to keep in mind the distinction between real estate and buying a home. Buying a house through the retail housing industry is a loser investment the majority of the time. Buying real estate, which treats property and rental homes as a business, can be both a good investment and an inflation hedge.
The returns from equities will typically beat out inflation, but the relationship can be volatile — and short-term results can vary widely. Equities can trump inflation as long as inflation stays low, like it has since 2009. The inflation hedge of equities is consistent only over a very long time frame. The value of equities as an inflation hedge can also depend on the makeup of your portfolio, as some companies are better at passing along inflation-related expenses to consumers than others.
Adjustable Rate Funds
Adjustable rate funds invest money in instruments like short-term bank loans. Since those instruments renew periodically, the interest rates can be adjusted to market conditions. Funds like Fidelity’s Floating Rate High Income Fund seek to beat inflation by investing in short-term borrowing. The downside is that short-term loans are risky and, if the economy suddenly tanks, it can hurt the ability of small businesses to pay back those loans.
This chart at InflationData.com shows the returns of gold, stocks, and bonds over the years, adjusted for inflation. As you can see, you can’t predict which of those sectors is going to shine at any given time, so a diversified portfolio that maintains a fixed percentage in each category, employing dollar cost averaging, should even out the volatility, and easily keep fears of inflation at a comfortable distance.