October 25, 2008: Constructing An Inflation-Proof Portfolio
While the whiff of deflation is in the air, it does not take a prodigy to assume that with United States Treasury printing presses running at white-hot speed 24/7, inflation is more than a possibility. Based upon previous episodes of Government Gone Wild, we are about two years away from a significant period of inflation. It is wise to plan for the future.
What is the investor to do?
Importantly, arrange economic affairs in a way that reflects your expectations but, at the same time, allows for the possibility that those expectations may be wrong. You should hedge against your primary portfolio investments so that the inevitable surprises won't be catastrophic.
I have always admired a few of the investment themes published years ago by the late Harry Browne. Browne may have been dismissed by Wall Street elites during his time, but one of his ideas, advocating keeping funds in two distinct portfolios, the Permanent Portfolio (for assets deemed too precious for ego-driven investment whims) and the Speculative Portfolio (assets which could be used as chips placed on economic bets and can afford to be lost) continues to serve me well, since the 1970s.
Anticipating a probability of gradual and pronounced inflation beginning around mid-2010 would fall into the realm of the Speculative Portfolio.
Here are a few ideas that may inflation-proof this portion of your assets:
Gold: Always a store of value, it is generally accepted that the metal should be held during inflationary times through gold coins or in the commodity index itself, which for most investors would be the iShares' COMEX Gold Trust (IAU). Holding gold stocks is not a pure play in gold due to the vagaries of management and the politics where the mines are located.
Japanese Yen and Swiss Francs: The Swiss Franc used to be the currency haven of choice to hold value during hard times. I believe the Japanese Yen may also be useful in this regard. Ideally, a blend of both. Rydex has the product for you. CurrencyShares Swiss Franc (FXF) and CurrencyShares Japanese Yen (FXY) offer low expenses and a convenient method to own foreign currency hassle-free.
Real Estate: During modest inflation, real estate benefits from being able to defer and profit from interest and rental property deductions into limitless 1031 tax free (Starker Exchange)deferred or forever gains, or future capital gains if the property is not exchanged. Accumulating debt via the mortgage at a low interest rate prior to an inflationary spiral is another issue, but worth pondering by the investor. As many people will have to rent rather than buy, the passive investor may consider the iShares' Residential Property ETF (REZ) instead of direct ownership. I believe that no domestic political party will do anything except enhance individual and multi-family tax breaks. Follow the rhetoric. Track the money.
US Stocks:The U.S. stock market will be a poor to mediocre performer when a combination of inflation and, perhaps, tax policy changes occur to the chagrin of investors. Buying ETFs that feature a selection of securities with a long, positive history of performance and dividend increases, or Master Limited Partnerships that, for now, offer tax advantaged yields such as PowerShares' Dividend Achiever ETF (PFM) or MLP's such as Teppco (TPP), Kinder Morgan Energy Partner's Trust (KMP) or Energy Transfer Partners (ETP) may be considered.
US Government Securities: The obvious choice is to invest with inflation-protected securities, or TIPS. IShares' U.S. Tips Bond Fund ETF is a solid choice (TIP), amongst other funds and individual issues via Treasury Direct purchase.
Tax Avoidance: As Ben Franklin stated, "a penny saved is a penny earned". Financial planners and advisers, including pundits, will be spending a great deal more energy and creativity during an era of inflation advising investors on how to avoid taxes vs. shilling stocks for what I call naked profit (taxed) products. Investors will take advantage of these necessary wealth-preserving schemes to the chagrin of the government. While it is easy to remain one step ahead of fiscally punitive legislation, beware of products that are too complex, too expensive to implement or outright illegal.Avoiding taxes will become an art. You should become appreciative of that form.
Inflation-Protected Annuities (IPAs):More popular overseas than in the U.S., inflation-protected annuities may be worth considering after examining fees, risk and payout limitations. If a long period of inflation (and a more confiscatory tax policy) fit your economic scenario, take a look. IPAs are somewhat of a rarity at this time, and those that are available may have you pay a hefty price for protection. Look for the major players to enhance their IPA offerings in the near future. In the meantime, Vanguard and Fidelity offer non-ipa annuities that feature relatively low fees and basic options to help insulate the annuitant from a fixed payout nightmare during inflationary times. Swiss Franc annuities are available through Swiss banks and insurance companies. This instrument is popular throughout the rest of the world, although fees and payout may be suspect to validate this as a true inflation-taming instrument as it relates to the theme of this article.
I would avoid the temptation to utilize ETFs that juice positive or negative sectors during uncertain times. We have not experienced significant fears of inflation, government intervention into the markets, a marked difference in federal taxation policy or increased free-market regulation and subsidies until recently. These funds (ProShares, etc.) may come with unintended consequences that cannot be predicted or foreseen.
The above thoughts on this topic may assist the investor through an inflationary environment. The allocation of each facet is entirely a personal matter. Importantly, never bet the house on a likely economic scenario. You, and I, may be wrong.
What is the investor to do?
Importantly, arrange economic affairs in a way that reflects your expectations but, at the same time, allows for the possibility that those expectations may be wrong. You should hedge against your primary portfolio investments so that the inevitable surprises won't be catastrophic.
I have always admired a few of the investment themes published years ago by the late Harry Browne. Browne may have been dismissed by Wall Street elites during his time, but one of his ideas, advocating keeping funds in two distinct portfolios, the Permanent Portfolio (for assets deemed too precious for ego-driven investment whims) and the Speculative Portfolio (assets which could be used as chips placed on economic bets and can afford to be lost) continues to serve me well, since the 1970s.
Anticipating a probability of gradual and pronounced inflation beginning around mid-2010 would fall into the realm of the Speculative Portfolio.
Here are a few ideas that may inflation-proof this portion of your assets:
Gold: Always a store of value, it is generally accepted that the metal should be held during inflationary times through gold coins or in the commodity index itself, which for most investors would be the iShares' COMEX Gold Trust (IAU). Holding gold stocks is not a pure play in gold due to the vagaries of management and the politics where the mines are located.
Japanese Yen and Swiss Francs: The Swiss Franc used to be the currency haven of choice to hold value during hard times. I believe the Japanese Yen may also be useful in this regard. Ideally, a blend of both. Rydex has the product for you. CurrencyShares Swiss Franc (FXF) and CurrencyShares Japanese Yen (FXY) offer low expenses and a convenient method to own foreign currency hassle-free.
Real Estate: During modest inflation, real estate benefits from being able to defer and profit from interest and rental property deductions into limitless 1031 tax free (Starker Exchange)deferred or forever gains, or future capital gains if the property is not exchanged. Accumulating debt via the mortgage at a low interest rate prior to an inflationary spiral is another issue, but worth pondering by the investor. As many people will have to rent rather than buy, the passive investor may consider the iShares' Residential Property ETF (REZ) instead of direct ownership. I believe that no domestic political party will do anything except enhance individual and multi-family tax breaks. Follow the rhetoric. Track the money.
US Stocks:The U.S. stock market will be a poor to mediocre performer when a combination of inflation and, perhaps, tax policy changes occur to the chagrin of investors. Buying ETFs that feature a selection of securities with a long, positive history of performance and dividend increases, or Master Limited Partnerships that, for now, offer tax advantaged yields such as PowerShares' Dividend Achiever ETF (PFM) or MLP's such as Teppco (TPP), Kinder Morgan Energy Partner's Trust (KMP) or Energy Transfer Partners (ETP) may be considered.
US Government Securities: The obvious choice is to invest with inflation-protected securities, or TIPS. IShares' U.S. Tips Bond Fund ETF is a solid choice (TIP), amongst other funds and individual issues via Treasury Direct purchase.
Tax Avoidance: As Ben Franklin stated, "a penny saved is a penny earned". Financial planners and advisers, including pundits, will be spending a great deal more energy and creativity during an era of inflation advising investors on how to avoid taxes vs. shilling stocks for what I call naked profit (taxed) products. Investors will take advantage of these necessary wealth-preserving schemes to the chagrin of the government. While it is easy to remain one step ahead of fiscally punitive legislation, beware of products that are too complex, too expensive to implement or outright illegal.Avoiding taxes will become an art. You should become appreciative of that form.
Inflation-Protected Annuities (IPAs):More popular overseas than in the U.S., inflation-protected annuities may be worth considering after examining fees, risk and payout limitations. If a long period of inflation (and a more confiscatory tax policy) fit your economic scenario, take a look. IPAs are somewhat of a rarity at this time, and those that are available may have you pay a hefty price for protection. Look for the major players to enhance their IPA offerings in the near future. In the meantime, Vanguard and Fidelity offer non-ipa annuities that feature relatively low fees and basic options to help insulate the annuitant from a fixed payout nightmare during inflationary times. Swiss Franc annuities are available through Swiss banks and insurance companies. This instrument is popular throughout the rest of the world, although fees and payout may be suspect to validate this as a true inflation-taming instrument as it relates to the theme of this article.
I would avoid the temptation to utilize ETFs that juice positive or negative sectors during uncertain times. We have not experienced significant fears of inflation, government intervention into the markets, a marked difference in federal taxation policy or increased free-market regulation and subsidies until recently. These funds (ProShares, etc.) may come with unintended consequences that cannot be predicted or foreseen.
The above thoughts on this topic may assist the investor through an inflationary environment. The allocation of each facet is entirely a personal matter. Importantly, never bet the house on a likely economic scenario. You, and I, may be wrong.
posted by T @ 10/24/2008 07:49:00 PM
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