Investing for Inflation

One of the things I noticed on my trip last week was, that after returning to a city where I hadn’t been in about a year, inflation seemed rampant.  Lunch at the deli downstairs from the office was about $9, last year I thought it was about $7.  Public transportation costs were up by 20% from a year ago, and taxis seemed downright expensive.  Given the scarcity of bonuses or pay raises, inflation has the risk of quickly eroding purchasing power and the real value of cash.

With the government aggressively trying to stimulate the economy out of its doldrums, it seems we are setting ourselves up for a bout of inflation, perhaps more serious than we’ve seen in the recent past.  From an investment cycle perspective, it seems that now is the perfect time to scale into investments that will perform well over the next several years in an inflationary environment.  With the news full of doom and gloom and reports of companies scaling back, this is precisely the time, as I posted on before, when one should consider investing more. These are the assets that I’m looking at, with a 5-year horizon in mind:

–Growth stocks – growth stocks tend to be good inflation hedges as the aggressive growth rates tend to run ahead of the general market.  I’m looking at technology and consumer cyclicals.

–Non-US$ investments — given the aggressive stimulus coming from the US government relative to the European governments, there’s a real chance that the US dollar could weaken significantly in the next couple of years.  I had scaled back my investments in non-$ funds and ETFs and may look to shift in the other direction soon.

–Inflation-indexed Treasuries or TIPS — bonds usually perform poorly during bouts of inflation.  Not only do nominal interest rates rise, but inflation eats into the real value of the fixed cash flows.  Fortunately, the US Treasury issues TIPS where the bond repayment is indexed to inflation.  Look for TIP mutual funds to have a diversified pool of securities

Of course, in regular business cycles, real estate tends to be a good investment during inflation.  Unfortunately for most home owners, the got in during the frothy part of the real-estate bubble.  I am still expecting that real estate still has some correction to go, so this particular business cycle may be quite unique.

see also my post on Inflation Investing: the Money Illusion

see more at this week’s Carnival of Personal Finance