June 27, 2014

Is Inflation Imminent?

Throughout the economic recovery, as the Federal Reserve has injected wave after wave of liquidity into the economy, the increase in dollars hasn’t had the inflationary effect many investors and consumers have been anticipating. Is that inflationary effect yet to come, peeking from around the corner? While there is no way to see the future, investors are starting to look over their shoulders and wonder if inflation is imminent.

How do investors mitigate the risk of inflation? Inflation is just a reflection that the prices of real assets — including everything from grain to gold — are increasing. Therefore, investing in a basket of diversified real assets can be a hedge against inflation, the idea being that the “real assets” in your portfolio will increase in value as inflation rises. That basket might contain commodities, real estate, and natural resources stocks, among other things. Treasury Inflation-Protected Securities, or TIPS, are created expressly to protect against inflation and can be another valuable instrument for a portfolio.

While these are useful tools specifically intended to guard against inflation risk, the best risk management tool is to view inflation risk in the context of your entire portfolio. Diversification is the first key to managing risk. Make sure your portfolio is well diversified across a variety of asset classes. Because it is impossible to know when inflation (or deflation!) may break out and how severely, we suggest that you structure your investment strategy with your long-term objectives and risk tolerance in mind. Utilize the risk management tools at your disposal, but keep a long-term perspective rather than focusing on short-term events.