Tame Inflation

Tame Inflation

Inflation is big news lately. Government spending is at a scary level. The Fed is parachuting money onto Wall Street. It’s very sensible to wonder what inflation is going to do in the near and medium term, and to wonder what you should do about it. I’m looking at an article by Jason Zweig of the Wall Street Journal, and he’s suggesting something called TIPS as an inflation hedge. What makes TIPS interesting as an investment is the fact that its performance is indexed to inflation. In other words, inflation has less of an impact on this investment type than others.

Compare it against fixed income investments, like bonds. In a worst-case scenario, you’ve got all your money in bonds that get 5% interest, but inflation is at 5% too, so the money you “earn” from your investment can only buy you the same goods that it could when you put it into the investment. TIPS helps by paying you back either the original principal value, or an inflation-adjusted value, whichever one is higher.

I like TIPS, and think that in moderate amounts, it’s a great thing to add to a portfolio. But I do have a concern. TIPS is indexed using CPI-U, the Urban Customers portion of the Consumer Price Index. And as I’ve pointed out in other articles, I think CPI may not be the most honest measurement of inflation, thanks to governmental manipulation of the formula used to measure it. Some analysts believe that the current government number of less than -1 percent is way too low, and that the correct number – the “shadow inflation” – may be as much as 6 percent. I’m not trying to be conspiratorial here, but even if we meet halfway between those numbers, we need to be thinking about the impact of inflation on our portfolios.

The bottom line is that even with access to useful inflation-hedging products like TIPS out there, the basics of portfolio management haven’t changed. A broadly-based, properly balanced, diversified portfolio is still the best hedge against inflation. TIPS can be a part of that balance, but investors would be wise not to put all their eggs in one basket.

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