Three Strategies to Help Manage Your Inflation Risk

Protecting from a High Inflation Rate
There are several ways you can consider protecting your portfolio from a high inflation rate. They may not be appropriate for everyone but you should at least talk them over with your financial adviser. Nick Koudis, Photodisc, Getty Images

With the United States Government running record deficits, I hear a lot of concerns by new investors about how to protect their portfolio from high inflation rates. When the proverbial printing presses start churning out dollars all hours of the day and night, it is a fairly good guess that prices are going to increase as money becomes less valuable, shrinking in purchasing power.

How can you protect from those high inflation rates?

What can you do to position your family's wealth in a way that you can sleep soundly at night? There are no foolproof methods but there are some things you can consider with a good financial planner. Done correctly, they have the potential to significantly reduce your risk from inflation shocks.

Inflation Tip #1: Avoid a High Concentration of Long-Term Bonds in Your Portfolio

When it comes to worrying about the inflation rate, bonds are the single most vulnerable asset class. In fact, inflation can destroy the net worth of a bond investor just like moths eating and destroying clothing. Often, by the time you notice, it is too late. This happens because most bonds receive a fixed coupon rate that doesn't increase. If you buy a 30-year bond that pays a 4% interest rate, but inflation skyrockets to 12%, you are in serious trouble. With each passing year, you are losing more and more purchasing power regardless of how safe you think investing in bonds is.

I explained this in an article called Is Investing in Bonds Safer Than Investing in Stocks?.

Inflation Tip #2: Own Investments That Can Increase Cash Flows

If costs increase, McDonald's can increase the prices they charge for Big Macs and fries, right? If costs increase, an insurance company can charge more in premiums, right?

If costs increase, an apartment building owner can increase rents in most areas of the country, right? These are examples of businesses or real estate that have some built-in protection from a rise in the inflation rate. If the investments you own have pricing power, you can survive bouts of high inflation without getting hurt too badly.

Inflation Tip #3: Own Commodities That Move Independently from Currencies

If you own a farm that produces commodities such as wheat or corn, oil fields that pump out crude, gold, silver or copper mines, or other assets that trade like commodities - think fine art or collectibles - you probably aren't going to need to worry about inflation as much as you otherwise would have. If people need oil, or wheat, or gold, they will pay for it in whatever currency you will accept, even if we are back in the stone age, trading sea shells and feathers. I know of several extremely rich investors who were buying farm land in Canada a couple of years ago because they believed that the United States was going to suffer significant inflation and a much weaker dollar as a result of our out-of-control deficits. They knew that the ability to own farms producing commodities in a foreign country would provide them with a potential anchor.

The Bottom Line - You Can Protect Yourself from a High Inflation Rate

The bottom line is that you don't have to suffer from a high rate of inflation. There are steps you can take to reposition your investment portfolio to safeguard against a loss in purchasing power. Intelligent investors can even find opportunities to profit from inflation.

More Information About Inflation and the Inflation Rate

To learn more, read The New Investor's Guide to Inflation and the Inflation Rate, a special that answers questions such as: