Simply put, inflation is on the rise. What are savvy investors doing to keep up during a period such as this? There are viable assets which help position a portfolio to respond positively as inflation marches along.
Generally, many assets that respond well to inflation are in the asset class called commodities, or alternative investments. These include food, energy, metals, real estate, and the less volatile inflation-protected bonds (TIPS). I consider real estate a commodity, and especially so if you are looking for real estate other than a primary residence. There is also one more surprise asset class, which is addressed near the end of this Blog.
Inflation-friendly asset classes are very risky, meaning the market price can and will change quickly, sharply, and often unexpectedly. Interested investors should keep only a small percentage of their portfolios in alternative investments.
Commodities. Most people do not want to invest directly in commodities. After all, how many pork bellies can one family consume? How about a train car load of corn being dumped on your front lawn? Not practical. Most investors prefer options, index funds, or some other form of ownership for commodities. Our amazingly flexible markets make this easy for all of us. General commodities index shares can be purchased in any of several Exchange-Traded Funds, or ETFs.
Real Estate is an often-misunderstood investment. Excluding your primary residence, do you really want to own real estate? Personally, I would prefer to avoid being called the “L” word – Landlord. How, then, can we buy real estate, hold it, reap the benefits, and eventually sell it?
As an investor, I prefer Real Estate Investment Trusts, or REITs, for fractional ownership interests in properties other than my home. REITs come in several forms, but the main ones are Mortgage REITs, which own mortgages on properties, Equity REITs, which own the actual properties, and Hybrid REITs, which are chartered to own either or both. I prefer the Equity REITs, as they have the ability to realize property appreciation in a rising market, while paying investors nice dividends during the ownership period.
Precious Metals. One of the most popular (and, likely the riskiest) commodity investment choices is precious metals, which range from the most common gold and silver, to exotic metals such as platinum. Again, these can be purchased several ways, but I prefer the ETF form for its marketability. Staying with gold and silver, we are inundated with advertising touting the ownership of the physical metals. I have no problem with people who prefer the look, feel and safety of gold and silver coins and bars, but in an investment portfolio, I prefer Exchange-Traded Funds.
TIPs. For the less speculative investor, there is another inflation-loving asset we frequently use in our portfolios. The Treasury Inflation-Protected Bond, or TIP, is a non-equity holding that is not closely correlated with the stock market. There are several ETFs that hold these inflation-indexed bonds, and each has its own objective. Potential investors should read the Prospectuses before investing.
General Market. Finally, the stock market itself is capable of helping us deal with inflation. Over time, inflation tends to drive the market up, simply because sales and profits numbers get larger. Investors holding the market index shares will generally benefit over time. In order to realize total market gains, broad-based index shares, such as the Wilshire 5000 composite tracking ETF, best reflect overall market rises.
Finally, we are fortunate to have most of our private homes appreciate over time in normal conditions. Granted, if your timing on the purchase proves to be horrible (e.g., 2006), it may take a long time to recover, much less to show a gain. But that isn’t the end of your financial world. Generally, the roof over your head, which may not be considered an investment, will prove to be an intelligent and rewarding lifestyle choice.
Understanding inflation can help investors cope with their otherwise declining standard of living, as income growth usually falls short of actual price level increases. If you need help with inflation planning, use a qualified, fee-only CFPÒ or call the show. We can help direct you through the investment planning process.
Van Wie Financial is fee-only. For a reason.