Getting Ready For Inflation
- Alan Lavine and Gail Liberman
It never hurts to be prepared when it comes to inflation.
Economists expect that the huge government deficit, growing economy and the declining value of the dollar will result in higher inflation. No one knows for sure how high inflation will rise. But when it does, wešll know. Wešll be paying even more for everything we buy.
Typically, when inflation is on the rise, interest rates rise. And when interest rate rise, bond prices fall.
Inflation may not hurt the stock market. The reason: Companies can charge more for their products and increase their profit margins. Stocks historically have returned about 7 percent more than the inflation rate over the past seven decades. Inflation has averaged about 3 percent, while stocks have grown at a 10 percent annual rate.
Financial advisers often recommend that you keep about 5 percent to 10 percent of your investments in inflation hedges. Today there are a lot of such investment options to consider. They include:
- Precious metals mutual funds and gold bullion. Historically, gold prices rise when inflation rears its ugly head.
- Real estate typically does well during periods of higher inflation. Leo Wells, president of the Wells Real Estate Funds, says that historically, on average, real estate delivers a total return that is about 4 percentage points higher than the inflation rate. So if inflation is 3 percent, real estate on average returns 7 percent.
- Inflation-indexed U.S. Treasury Bonds. The bondsš principal value increases with the rate of inflation as measured by the Consumer Price Index. After 10 years, if we experience 3 percent inflation, for example, your $1,000 bond should be worth about $1,344. Your maturing bond value should maintain its purchasing power.
- Inflation-indexed U.S. Savings Bonds. The interest rate on your bonds rises with inflation tax-deferred. When the bond matures, you collect accumulated principal and interest.
- Brokerage firms now sell inflation-indexed CDs as well as inflation-indexed corporate bonds. So the purchasing power of your investment should hold its value.
Inflation-linked investments can be volatile--especially gold and real estate. So itšs best to invest regularly so the cost of your shares is lower than the market price when you sell.
Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).
To read more columns, please visit the column archive.