Vance L. Falbaum 0000-00-00 00:00:00
If Inflation Heats Up, How Should Investors Respond? Over the past few years, inflation has been pretty low. But if it heats up, what would that mean to you as an investor? Of course, if you've been to the gas station or the grocery store recently, you may think that it's not a question of "if" inflation takes off, but rather "how high will it go?" And it's certainly true that we've seen a jump in the prices of commodities, such as oil, wheat and corn. Yet, we may not be facing an imminent and significant rise in generalized inflation — the type that raises prices across the board for an extended time. Nonetheless, as an investor, you need to constantly be looking at what the situation may be like tomorrow, not just today. So, if we were to enter an inflationary period, what moves might you consider? • Calculate Your Assets and Debts A seemingly simple task may provide a lot of clarity when laid out in front of you. By simply tallying your assets - bank accounts, investments, retirement accounts, real estate, business interests, etc - as well as what you owe to others - mortgages, equity loans, auto loans and credit cards - you will have an up-to-date snapshot of your current financial picture. From there decisions can start to be made more accurately. Perhaps there are loans you can pay down quickly (hint - credit card debt is typically the biggest culprit of them all)? Perhaps you need to move your investments into new areas. A financial consultant can help you make these decisions. • Decide between Every Day Needs versus Wants In a commercialized society, we've become all too dependent on items we at one time viewed as luxuries or even frivolous expenditures. Similar to the tip above, make a list of all of your monthly expenses and start to identify areas where cuts can be made. For example, food is essential but do you need to buy all groceries from the gourmet food store? Or are 200 cable channels necessary? How many bells and whistles do you really need for your cell phone? Are you utilizing your memberships enough to justify continuing them (i.e. - gym memberships, online video rental, etc)? Whether you keep spending money on these expenditures or not, a complete picture will help you decide areas of less importance where you could cut back. • Review your fixed-income holdings. Some types of fixed-income investments, such as Certificates of Deposit (CDs), pay rates that may barely exceed the rate of inflation — so if your portfolio has a large percentage of these vehicles, and if inflation rises noticeably, you could be losing purchasing power. You may need to rebalance your holdings so that you have a mix of growth- and income-oriented vehicles. • Build a bond "ladder." If inflation does take off, the Federal Reserve may respond by raising interest rates. If interest rates rise, the price of your existing bonds will fall, because no one will pay you full price for your bonds when they can buy newer ones at higher rates. To deal with this interest-rate risk, you might want to build a bond "ladder" consisting of bonds of varying maturities —short-term, intermediate-term and long-term. Once you've constructed your ladder, you'll have some advantage in all interest-rate environments. When market rates are low, you'll still have your longer-term bonds earning higher interest rates. And when market rates rise, you'll be able to reinvest your maturing short-term bonds at the higher levels. • Invest in TIPS. When you invest in TIPS (Treasury Inflation-Protected Securities), your regular interest payments and your principal (the amount you'll get back when your bond matures) are both indexed to the rate of inflation, as measured by the Consumer Price Index. Be aware, though, that TIPS typically pay lower interest rates than "nominal" Treasury bonds of similar maturities. Consequently, if you think inflation is going to be higher than the difference in interest rates (between TIPS and nominal Treasury bonds), TIPS might be a good choice. • Look for dividend-paying stocks. One of the best ways to combat inflation is through investments that offer rising income — such as dividend-paying stocks. Some companies have paid, and increased, their dividends annually for decades. Keep in mind, however, that companies can reduce or discontinue their dividends at any time. It's not easy to predict either the timing or the scope of inflation. But it won't hurt to speak to a financial advisor about some of the ideas outlined in this article and to follow the Boy Scout motto: "Be Prepared."
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