Why You Need Inflation Protection Now

Almost no one is worried about inflation. You should be.

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Too often savers and investors fight the last war when they should be girding for the next one. Just a year ago, people were afraid to buy residential real estate. Homeowners had lost a collective $7 trillion in equity following the Great Recession. Buy a house? You’ve got to be nuts.

But they were fighting the last war. Today, home prices are up double digits and rising mortgage rates have further put homes out of reach for folks who could have been buyers a year ago, when the war on real estate values was already over. What should we have been preparing for? One example: gold prices are down 17%—and signs of over valuation were in plain view last year.

This isn’t to say that we should all have a crystal ball. Trend reversals are easy to spot only in hindsight. But failing to account for their inevitability can be a costly mistake—one that a lot of pre-retirees are making right now as it relates to inflation.

Consumer prices have been so tame for so long—no annual reading as high as 4% in 22 years—that inflation is practically a forgotten scourge. Yet we’ve already turned an important corner. The Fed is preparing to taper its stimulus programs this fall and long-term interest rates, often a leading indicator for the price of goods and services, have begun to move up.

“Inflation cannot be combated through a rear-view mirror,” BlackRock analysts Phil Green and Michael Fredericks write in a report. “It has to be planned for before it picks up. We think investors should be building that insurance into their portfolios now.”

Inflation is a sneaky enemy. At just 3% a year it can erode your buying power by more than half over 25 years. So even with consumer prices rising only modestly a retiree with no way to earn more money needs to account for the impact. There is no easy solution.

Among the most popular inflation hedges are Treasury Inflation-Protected Securities, or TIPS. These are Treasury bonds that adjust for inflation rate. But if rates continue to rise, TIPS prices could fall enough to produce losses despite the boost from any inflation adjustment. Many analysts believe Treasury bonds and related securities like TIPS are especially risky at the moment.

What’s the answer? BlackRock advises a diversified approach to inflation hedges, which means owning some gold, Real Estate Investment Trusts, natural resources, TIPS, stocks and variable-rate bank loans. Not all inflationary periods are the same. But if, say, TIPS and stocks decline because rising rates have crushed bond prices and corporate earnings, odds are gold and variable-rate bank loans will do well.

This kind of broad inflation protection is most easily bought in a mutual fund or exchange-traded fund. One to consider is the BlackRock multi-asset real return fund, though you may be charged a fee to enter or exit the fund.

For TIPS exposure, it’s tough to beat the low-cost Vanguard Inflation-Protected Securities or the iShares Barclays TIPS Bond exchange-traded fund, according to research from Morningstar. Such funds can steer to lower risk shorter maturities in a rising rate environment. For variable-rate bank loans, Morningstar suggests Fidelity Floating Rate High Income and for commodities and precious metals the firm likes Harbor Commodity Real Return and iPath DJ-UBS Commodity Index.

Serious inflation may not become a problem for many years. But it is the war that no one is fighting at the moment—and at the least we should be getting ready.

2 comments
Whatanotion
Whatanotion

The vagueness of financial investing belies the artifice of the entire scheme that isn't selling well with the Boomers.  They sense the artificiality of the value of currencies and are justifiably paranoid about inflation and investing in anything.  Population decline isn't being talked about enough to educate the public.  The failure of  Immigration Reform looms like a giant signpost "You're so screwed you have to import workers that don't speak English! "   The rental property owners know who they are renting to and what they can expect from them as far as industrial production.  So a watermelon goes for $50 who really needs to eat a watermelon?