If you weren’t haunted forever by the inflation scare in the 1970s, you may have missed an important financial lesson that needs to be on the forefront of your mind when making decisions about money.
Inflation is a perfectly rational fear for investors because rising prices of consumer items, college tuition and healthcare erode the value of your retirement dollars. High inflation and taxes cut into the earnings you need to grow your assets.
While inflation has been relatively low over the last decade, you can’t count on that being the case forever. Someone retiring at age 65 has to consider the real possibility of needing a rising income stream for the next thirty years because life expectancy has increased.
Conventional wisdom says that gold is the best cure for inflation. However, gold’s record has been spotty. In the beginning of 1980, gold started at around $559/ounce and finished the year 2000 at about $275/ounce. Heavy gold investors didn’t keep up with inflation and they incurred losses that were hard to recover from.
On the other hand, investors of equities (measured by the S&P 500) did much better over that same period. Investors in stocks also had to survive two horrible corrections since 2000 but if you invested at that time and fell asleep for the last 17 years, you wouldn’t have noticed the carnage that took place. Of course, owning some gold over this period would have been the same as having a really nice dream while you slept! And, as usual, when you wake up to hear the late-night tv pundits pushing gold on seniors, the gold rally is usually near an end.
With the markets at or near all-time highs, you may be tempted to sell your holding and run for the hills. Unfortunately, the cash markets aren’t going to keep you safe from the inflation monster and gold isn’t very liquid.
You might want to consider looking at TIPS. Treasury Inflation-Protected Securities are a type of investment that adds to your principal as the CPI (Consumer Price Index) rises. Be careful though, these bonds are still subject to interest rate risk and they are taxable.
Still, one of the best ways to stay ahead of inflation is to purchase stocks of dividend-paying companies that have a long track record of increasing their dividends. Even if your principal takes a hit due to a market correction, you still have a steady stream of income to count on. Investors that have re-invested their dividends over time have been handsomely rewarded.
Also, stocks in the materials and technology sectors usually fare well during periods of higher inflation. Since inflation usually implies that demand is rising faster than supply, that means that the price of raw materials is climbing. Meanwhile, technology allows businesses to substitute machines for workers to keep costs down and profits higher.
So, when forecasts for inflation move higher, you have to make moves in your portfolios to compensate for the risk that higher prices will erode your investment earnings. There are many ways to diversify your risk so don’t be pressured when you see all of the late-night commercials on tv pushing gold. By then, it’s probably already too late to catch the gold bug anyways!