Stocks advanced yesterday approaching a 52 week high (Dow Jones +0.41%, S+P 500 +0.51% and NASDAQ +0.88%).  The market was calmed amid fears of a raise in  the base rate, however, the Fed kept lending rates down.  As more Investors have increased their holdings the markets have risen in value, which poses the question of rising inflation and how you protect yourself against the possibility of diminishing returns.

Those who are employed can ride an inflationary period through salary increases, but the fixed income retirees are most at risk from this erosion of income and spending power. Deflation was mentioned  by economists as a danger to the US economy, however, due to the fiscal stimulus package and growth in the Far East, inflation is the more likely result of these economic events, long term.  Thus, reevaluating portfolios is a necessary step in financial stability.

One of the recommended vehicles is through TIPS (Treasury Inflation Protected Securities) and iBonds.  They are a useful addition to your portfolio in negating the fluctuations in other markets and protecting your capital investment.  They also offer an opportunity to become Tax efficient, (please refer to your Tax Adviser for personal circumstances).

 

 

 

The iBonds, for example, are US savings Bonds and pay interest in 2 ways.  First is fixed when purchased; the second is variable, which changes twice a year based on inflation measured by the CPI.  The most recent iBond is paying 3.76% composite, based on a fixed rate of 1% and 2.67% varaible annualized.

Up to $5,000 can be invested in any calendar year (Source: Treasury Direct) purchased at a local Bank or electronically through Treasury Direct. You may also invest a one time only lump sum of $20,000. You must hold the bond for a minmum of 12 months, 3 months redemption of interest is charged if you cash the bond before 5 years. Careful selection is required to ensure that you are making income that is not being eroded by taxes and this vehicle may not offer protection to those in higher tax brackets.

TIPS are similar to iBonds, are guaranteed by Uncle Sam and are exempt from local and state tax.  You will be liable to personal income tax because of the bi-annual interest you receive plus the 'phantom income' you receive from adjusted inflation.  It is significant that you could be paying more in tax than you are actually earning, this despite the fact you do not receive this income until the bond is redeemed. TIPS though are an excellent vehicle for those who are in a lower tax bracket, who live in a state with high tax rates and are an ideal addition for inclusion in taxable accounts or Roth IRAs.  They are easily purchased, commission free, normally with starting prices of around $1,000 and up to $5M.

To further hedge your portfolio you may also consider purchasing commodities, at the very top between 5-6% of your portfolio.  Be cautious in your approach in buying as timing is everything.  Look at dollar cost averaging before you purchase.  A mistimed buy could easily be dented by inflation.  Do not discount that you may already 'hold' commodities in the form of energy stocks; energy prices, oil, coal and gas form a major part of the commodities market.  Particularly relevant when prices in developing economies are heavily reliant on selling raw materials.

Stock market investment is by far the most visible way of preventing erosion by inflation.  Companies with a history of solid dividend returns are worth owning and inflation will have a lesser effect on these returns than say, bonds.  A good source of data relating to the above can be found at the Vanguard Dividend Appreciation.  For Government Bonds call 0800-4US-BONDS.

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