One of the most overlooked factors in retirement planning is the effect of inflation. We all know that the price of good and services continually go up, and no matter your investing goals, you can’t ignore the eroding effect inflation will have your assets. In a study done by the U.S. Bureau of Labor Statistics, inflation has reduced Americans’ purchasing power in every year but two dating back to 1945. How do you like those odds?
The most commonly referenced measure of inflation is the Consumer Price Index (CPI).The CPI is based on a monthly survey by the U.S. Bureau of Labor Statistics and it compares changes in the prices paid by consumers for a representative basket of goods and services. The monthly CPI reading is widely considered a useful way to measure prices over time. In today’s economic environment inflation has largely been held in check, which is why it might be easy to overlook inflation when building your investment portfolio.However, there is growing concern that government spending which is designed to ease the recession and revive the U.S. economy could spark inflation.The U.S. will have committed over $12 trillion to solving the financial crisis according to Bloomberg. The U.S.Treasury will likely borrow a record $2.5 trillion this fiscal year, according to Goldman Sachs Group Inc.
Investing to Counter Inflation
Like stock returns, economic growth, and interest rates, inflation is one of those variables you can’t control. But, as an investor, you can control how your investment dollars are allocated. For many investors, investing in natural resources, precious metals and bonds that typically react favorably to inflation are ways to hedge against inflation in a properly diversified portfolio.
There are many ways that you can invest to combat inflation, One strategy that gets more direct exposure is by using ETF’s. The three main categories that you’ll want to focus on is gold, silver, or government bonds, energy and materials. You could compose the latter two by choosing individual stocks, but for the sake of diversification, we’ll just use an ETF.
Gold and Precious Metals
Typically, gold moves in the opposite direction of the dollar.The U.S. dollar has depreciated recently against the euro while the price of gold has increased according to Bloomberg. Additionally, the Federal Reserve has aggressively lowered the federal funds target rate in an attempt to boost the economy, but lowering the rate also tends to depress the dollar.This may encourage investors to continue to shift assets into commodities such as gold, which is historically known for holding value during times of rising inflation. Investing in the commodities themselves is not the only way to hedge against rising inflation. Mining companies also tend to benefit as their earnings should improve if the price of gold and other precious metals rise. Such hedging may also be accomplished by investment in ETFs which themselves invest in commodities such as gold and silver.
When economic activity accelerates, whether in the U.S. or abroad, the global demand for natural resources grows.The resulting increase in the underlying commodity prices historically generates higher profits for companies in the energy sector and translates into higher returns for investors.
The negative effects of inflation on bonds may be offset through ETFs which invest in inflation linked bonds. Inflation-linked government bonds, commonly known in the U.S. as Treasury Inflation-Protected Securities (TIPS), are securities issued by governments that are designed to provide inflation protection to investors.The coupon payments and principal value on these securities are adjusted according to inflation over the life of the bonds.
Gold/Precious Metals, and Inlation ETFs (50%):
- iShares Barclays TIPS Bond Fund (TIP)
- iShares COMEX Gold Trust (IAU)
- iShares Silver Trust (SLV)
- SPDR DB International Government (WIP)
- SPDR Gold Trust (GLD)
Energy ETF’s (25%):
Global Energy ETFs
- iShares S&P Global Energy Sector Index Fund (IXC)
Broad US Energy ETFs
- iShares Dow Jones U.S. Energy Sector Index Fund (IYE)
- iShares Goldman Sachs Natural Resources Index Fund (IGE)
- Energy Select Sector SPDR Fund (XLE)
- Vanguard Energy ETF (VDE)
Materials ETF (25%):
- Vanguard Materials ETF (VAW)
- SPDR Select Sector Fund- Basic Industries (XLB)
- iShares Dow Jones U.S. Basic Materials (IYM):
- iShares S&P Global Materials Sector Index Fund (MXI)