How to Invest in Preparation for Inflation
Although inflation inevitably means higher prices on most consumer items, it also means opportunity for investors ready to take advantage of this shift in the economy. Inflation means rising interest rates that usually fuel rising stock prices, and those who are foresighted enough to get in at the bottom can reap substantial profits. It helps to know what types of investment strategies can allow you to do this in the most effective manner.
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Instructions
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Evaluate your investment objectives, risk tolerance and time horizon, which is the length of time you plan to hold the investments before liquidating them. Decide how much money you want to put into bonds or other fixed-income securities and how much you want to put into equities. You may want to do some combination of the two, or all of one or the other. If your time horizon is at least 10 years, stocks may be more appropriate. A mix of debt and equity securities is probably appropriate if your time horizon is shorter than that. In general, the shorter your time horizon, the greater the percentage of equities should be in your portfolio.
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Create a laddered portfolio of bonds or certificates of deposit (CDs) with the portion of your portfolio that is allocated to debt. A laddered portfolio is one that has staggered maturies from short to long. For example, you could buy 10 bonds, and one of them will mature in three months. The second bond will mature in six months, the third in nine and so on. When each bond matures, you can purchase another bond that will hopefully be paying a higher rate of interest because rates will have risen by then as a result of inflation. Repeat this process as long as rates continue to rise.
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Consider the various sectors of the economy and types of companies that do well during periods of inflation when you create your stock portfolio. Companies that pay high, steady dividends often do well during periods of inflation, because many of these companies are retail firms that can pass rising costs directly on to their customers. Large multinational firms that are domiciled here can also do well, because inflation can weaken the dollar and thus reduce the price of exports for these companies.
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Hedge your bond portfolio with Treasury Inflation Protected Securities (TIPS), a special type of bond offered by the U.S. Treasury designed to protect against inflation. The principal and interest payments of TIPS are indexed to the Consumer Price Index (CPI), and the investor is paid the greater of either the original principal or the adjusted principal if inflation has risen. This can provide your portfolio some inflation protection without risking your principal.
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