Is Your Portfolio Protected Against Inflation?

The economy is going through a strange phase right now. It’s almost like everyone is holding their breath to see what happens next. While for the most part the economy is doing reasonably well, a key segment of it, namely the housing market is going through turmoil.

This has caused a chain of events that has led us to where we are today. Weakness in the housing market has caused severe problems in the sub prime mortgage industry, which then caused instability in the rest of the financial sector. This has in turn forced the Federal Reserve to cut short term interest rates, twice now in the past few months, as well as pump in almost $41 Billion in funds in an attempt to add liquidity to the system. All of this has raised a mounting fear of inflation in the marketplace.

Are your investments hedged against inflation? Most normal investors will hold a mix of stocks and bonds in their portfolios. But how well will they do in times of high inflation? Typically not so well. Stocks will tend to fall in anticipation of higher interest rates to combat rising inflation. The price of long term bonds will fall as investors will demand higher yields in an inflationary environment.

So what does well during high inflationary periods? Well, I’ve already mention in some of my previous articles how food and energy prices have been skyrocketing lately, which are the main reasons why most people are afraid of inflation now. Might it not be wise to invest in those markets? I am of course talking about the commodities market. Now usually this market is for the most sophisticated of investors, those that are familiar with futures and options. However there are some mutual funds that invest in these markets so anyone can get in on the action.

Other areas that tend to do well are precious metals and foreign investments. Precious metals will usually keep pace with inflation. As for foreign investments well, if our country has a higher inflation relative to another country, our currency would grow weaker against that other nation’s currency. However, that just means that when you finally do convert those investments back into dollars, you would have more dollars from the foreign investment than you would if you had gone with a similar domestic investment with the same rate of return.

Now we come full circle. The final area that usually does well in a high inflationary period is none other than the real estate market. So while these lower interest rates may eventually fix the sagging housing market, they may wreck the rest of the economy to do it. Isn’t if funny how these thing turn out?