If you don’t think inflation could rear its ugly head again, you could be fooling yourself. Currently, the Obama administration is most worried about price deflation. But recent events could change that outlook.
For starters, the federal government is spending money at an unprecedented clip. It has approved a $787 billion stimulus program, a budget of $4 trillion (up from $3 trillion the prior year), and hundreds of billions more in rescue packages. Also, short-term interest rates, guided by the Federal Reserve, have hit rock-bottom, and rates are quite low in other countries, too.
All of this is kindling waiting for a spark. Once ignited, growth and inflation could come roaring back to life.
For that reason, it’s smart to allocate a portion of your fixed-income investments to Treasury inflation-protected securities (TIPS). These bonds are backed by the U.S. government, and have built-in protection that boosts their value when inflation rises. Since inflation might not return for a few years, and TIPs currently have extremely low nominal yields, averaging into these investments over time could be a better strategy than investing a large sum all at once.
Another inflation-hedging strategy is to invest in commodities. When growth resumes, demand for oil, copper, and other commodities will rise, increasing their prices. But given the volatility of commodities, it’s generally recommended that you keep no more than 5% to 10% of your portfolio in this asset class. |