Protecting against inflation

(Inflation 1923-24: A woman in Germany feeds her tiled stove with money. The money is worth less than firewood.)

In my recent post, inflation revisited, I mentioned that there are ways we can protect our personal assets from the ravages of inflation. After publishing the article I received some requests for ideas and information on how to do that. Sorry for the delay in responding. Here are some things I've found that I believe could be helpful. These are just a few resources to serve as a jumping-off point for conducting your own in-depth research.

The problem inflation poses for your investment portfolio is of course the erosion of its purchasing power. If you earn a 10% return but inflation is in the double digits you would actually be losing money. The key is to find asset classes that are negatively correlated to cash and cash equivalents and traditional asset classes like bonds, mortgages, real estate and stocks. Historically this has been the realm of precious metals (such as gold and silver,) and commodities. There is a ton of information out there about investing in gold as it has become a hot topic over the past few years. Here are two articles (Protecting Your Savings from Inflation and 10,000 Gold) I found informative on the subject. There is a lot more that can be found just by searching around on the web.

The Daily Reckoning is a free e-letter that contains commentary on the financial scene and the world in general. The DR guys are contrarians and they're big on gold so I would recommend it. It's highly entertaining as well. The thing with gold (and other precious metals) is that it isn't the kind of asset that gives you a return under normal conditions. It's insurance against depreciating currencies. When currencies fail, it will protect your portfolio and can provide additional gains as well. It's good to keep a percentage of your portfolio in gold at all times just in case. Then when you really fear that inflation will take off, buy substantially more.

Commodities can play the same type of stabilizing role as gold but they are a little more tricky. Here's a very simple article on the subject: The Importance of Commodities in a Portfolio. The part most relevant to our purposes is this: "The diversification benefits equal or surpass those of other asset classes like fixed income and real estate. The primary reason for this is their correlation, or lack thereof, to the stock market as represented by the S&P 500 (Correlation describes how similar the price movement is between two investments). Commodities have historically exhibited absolutely no correlation whatsoever to the stock market or any of the bond market indices. In fact, they have a negative correlation. This non-similar pattern of performance allows an investor to minimize volatility and protect capital in down markets. Overall, these factors help to decrease overall risk in a portfolio of investments."

The trick with commodities is to choose carefully the ones that historically are the most likely to rise with inflation. Here's a good introduction on how to do that: Commodities And The Inflation Rate. Here's another pretty good article (PDF) about commodities investing and how it applies to inflation: Asset Class Review: Investable Commodities: Part 1. If commodities are something you're interested in I would recommend reading Hot Commodities by Jim Rogers. It's a good primer on the subject.

Another solution would be to buy currencies or traditional assets (stocks, bonds, real estate, etc.) in other countries where they are denominated in currencies that you expect to hold stable vs. the dollar. This may be difficult because the dollar has over the recent past been the world's stable currency; the one the world runs to when they fear instability at home. Since the dollar is the world's reserve currency, a severe drop in the dollar could have a highly unpredictable effect on other currencies, but the idea is still to locate one that you think will remain stable. An excellent and free advisory about currency movements is The Daily Pfennig.

As far as investing in international markets, I think it's one of the most important things an investor can learn how to do these days. The real money over the next few decades will be made overseas. This is no easy task. It can be very risky and you really have to understand a country's government, its history and regional and world geo-political conditions as well as the fundamentals of the particular investment you're considering, but the potential gains for those who do their homework are huge. A book I would highly recommend is The Bull Hunter by Dan Denning. He recently traveled Asia and has some good insights. He also talks a lot about using ETF's (Exchange Traded Funds) which I think is a good idea. Another good book on making money despite the dollar's instability is The Demise Of The Dollar... And Why It's Great For Your Investments by Addison Wiggin.

Hopefully some of you find this list helpful. There's truly a wealth of information out there on all these topics so there's nothing stopping any of us from using this stuff to make money and protect what we have. This does not in any way constitute investment advice. I'm simply giving my opinions on what I believe can help protect us from what I see as an increasingly likely inflationary scenario. As always, do your own due dilligence and understand the risks before you make any decisions.