Inflation makes comeback: Act now to manage investment risk

With years of profligate spending behind and staggering liabilities for Social Security and Medicare ahead—plus the recent financial bailouts—the federal government will be hard-pressed to keep its commitments on promised benefits.

Are leisure suits and 1970’s-style inflation poised for a comeback? Not quite, but inflation will be severe enough to profoundly affect all investments.

With years of profligate spending behind and staggering liabilities for Social Security and Medicare ahead—plus the recent financial bailouts—the federal government will be hard-pressed to keep its commitments on promised benefits.

Devaluing the currency via creeping inflation is one way the government can make good on promised benefits. Remember that inflation is good for debtors (like the government) but bad for lenders (bondholders).

The Federal Reserve Bank is a creature of government, and it may be worth asking ourselves thoughtful questions about where its loyalties might lie when push comes to shove. Well, might the ever-resilient U.S. economy actually grow into those obligations by embracing pro-growth policies and toning down the role and cost of government? Of course that is possible in the sense that almost anything is “possible.” But, given the ascendance of populist politicians, it is probably not the way to bet!

While you can’t eliminate the risk inflation poses to your investments, you can manage it:

• Energize. Short-term, energy prices could decline, but long-term the outlook is bullish. Energy stocks should be a core holding.

• Take TIPS. Treasury Inflation Protected Securities, or TIPS, whose rates go up when inflation increases, are a better deal than Treasury bonds, which sport low rates today.

• Golden opportunity. Gold-bullion ETFs belong in almost every investor’s portfolio as a hedge against declining paper currencies.

• Where credit is due. Be selective about taking on credit risk. Short-term government agency debt is unexciting, but it’s safe and may outperform Treasuries.

• Cash in. Keep ample cash so you can pounce on opportunities. When stocks of companies with a bright long-term future decline sufficiently, you want to be able to jump on them.

J. Michael Martin, CFP, is president of Financial Advantage, Inc., in Columbia, Md., which provides personal financial planning and investment-management services to retirees and aspiring retirees on a fee-only basis. Wealth Manager magazine has named Financial Advantage as one of the top 200 independent financial advisory firms in the country. Web: www.financialadvantageinc.com. He can be reached at mmartin@financialadvantageinc.com.