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Tags: inflation | tax | portfolios

It May be Time to Put Inflation in the Equation

Monday, 23 June 2008 09:23 AM EDT

Surging costs for gasoline and food might elicit the most groans about rising prices, but inflation can also tax a portfolio. Investors who aren't mindful can find the composition of their holdings makes about as much sense as a fuel-hogging SUV.

People don't necessarily need to rush to outfit their portfolio with defenses against inflation. However, some well-considered steps might be appropriate, economists say.

"I think you're in an environment where people are wondering what to invest in at all because you're looking at the safest investments — like a short-term investment in a money market fund or a Treasury bill — that obviously have very low returns," said Ethan Harris, chief U.S. economist at Lehman Bros. in New York.

"I don't think there is any magic answer on what to invest in. I think people have to have realistic expectations that you're going to be in a period of higher-than-normal risk and a little bit lower-than-normal returns."

A Vote for Diversification

Harris contended that investors should, as always, take a long-term view and make sure their portfolios remain well-diversified.

"It's not like you can look at any asset class and say one area is much better than others," he said. "You have an economy that's really just trundling along in the mud here, and I think that six months or a year from now you're going to have a better picture."

Recent readings haven't been heartening. The Labor Department's consumer price index rose at a 0.6 percent rate in May, slightly more than expected. And excluding often-volatile food and energy prices, inflation edged up a more moderate 0.2 percent.

For investors who believe their portfolios need some fortifying to fight inflation, there are traditional defenses such as commodities or real estate investment trusts, said Sean Simko, head of fixed-income management at SEI Investments in Philadelphia.

Slow Steps on Commodities

With oil prices having nearly doubled in the past year, some observers contend that a bubble has formed in the energy markets. So Simko advises investors who are considering wading into the volatile commodities markets do so gradually.

"You don't want to be buying at the highs. If you have a long-term perspective I would say you could probably take a look and slowly dollar-cost average into an investment," he said, referring to the process of investing a fixed amount at regular intervals to avoid having decisions be swayed by the market's ups and downs.

He said investors with large portions of their portfolio in cash might want to consider alternatives.

Investors could consider tapping into investments that try to keep pace with inflation. Some mutual funds or exchange-traded funds, which are like mutual funds but trade like a stock, invest in what are known as Treasury Inflation-Protected Securities, or TIPS. The principal on these Treasury investments is linked to government inflation figures and increases as prices rise.

Less Worried About Inflation

Keith Hembre, chief economist for First America funds in Minneapolis, contended, however, that inflation pressures are better contained than they might appear, and that the rise in energy and food prices will eventually cool so that shifts to a portfolio to beat inflation shouldn't disrupt a long-term investing plan.

"We're modestly defensive in this environment. If we thought there was a sustained inflation problem we'd be a lot more defensive," he said. He predicted that a slowdown in demand from abroad because of rising prices will help cap some of the inflation pressures and said that U.S. markets aren't signaling a serious worsening of inflation.

"If you get beyond the commodity prices, there is very little inflationary pressure evidence in most of the other areas of the economy. And the increase in energy and commodity prices is being driven by largely external forces," he said, pointing to such factors as demand from economies abroad.

Investors could get a better sense of where the government's inflation watchdogs think prices will go when the Federal Reserve meets this week to decide on interest rates.

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Surging costs for gasoline and food might elicit the most groans about rising prices, but inflation can also tax a portfolio. Investors who aren't mindful can find the composition of their holdings makes about as much sense as a fuel-hogging SUV.People don't necessarily...
Monday, 23 June 2008 09:23 AM
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