Five Ways to Protect Your Assets from "Stagflation"

Slowing economic growth, high unemployment, rising gas and food prices -- are we seeing a return to 1970s-style "stagflation"? If so, the next few years could be bumpy. Here what investors can do to protect themselves.

A few months ago, an investment banker in New York City told me he believed the U.S. was in a state of stagflation. “There is less choice now than before,” he said. Though his explanation sounded strange, it got me thinking.

The traditional definition of stagflation is slow economic growth, accompanied by high unemployment and rising prices -- definitely consistent with our current economic situation. The U.S. economic-growth rate was recently cut to 2.6% from 3.3%. The unemployment rate remains at a relatively high 9.6%. Rising gas and food prices can be seen everywhere. Yet no one is talking about the big “S” (stagflation).

One reason might be that concept of stagflation is so upsetting that few want to acknowledge it. Those who lived through the 1970s can likely attest. Back then, unemployment was high and inflation raged, climbing to 13.3% by 1979. Gold and oil prices soared, while the dollar weakened against foreign currencies. The stock market was flat.

If we are indeed seeing a return to 1970s-style stagflation, what can an investor do about it? Here are five ways to shore up your finances:

Control What You Can. Pay off any creditors that aren’t charging a fixed low interest rate. Interest rates on credit lines of the flexible variety may skyrocket in the near future, so it’s better to pay down your debt while rates are still relatively low.

Inflation-Proof Your Bond Portfolio. Invest in Treasury Inflation Protected Securities (TIPS). The value of TIPS rise with inflation and decline with deflation, as measured by the Consumer Price Index. When a TIPS bond matures, the investor is paid the adjusted principal or original principal, whichever is greater. The bonds generate interest twice a year at a fixed rate, which is determined at auction.

Re-Evaluate Your Stock Holdings. It is essential to stay in the stock market, since stocks historically have outperformed bonds. Dividend-generating stocks, or exchange-traded funds, or mutual funds are a plus in an atmosphere of stagflation, since you get an income while waiting for prices to rise. (Of course, it’s most important to ensure your stock portfolio is properly diversified.)

Avoid "Alternative" Investments. Now is not the time to be loading up on “alternative” investments, such as minerals (gold, silver and platinum) and real estate. The latter includes physical property or real estate investment trusts (REITs). While real estate and REITs historically perform well over time, short-term performance can be dicey and real estate’s carrying cost may turn out to be exorbitant over the number of years it will take the flooded housing market to work itself out. As for gold, which is breaking records every day, some are already questioning whether prices have peaked.

Cash Is King. Having a sufficient amount of emergency savings in cash investments, such as CDs, high-yield savings accounts and money-market accounts, is critical in a stagflation economy. Stick with shorter-term CDs — you don’t want to get locked into today’s rock-bottom yields when interest rates start climbing.