Turn on any cable news channel and you’ll hear the same theme: inflation is coming. There’s no getting around it–we don’t know exactly when, but it’s coming. You can’t create a trillion dollars out of thin air and expect the purchasing power of a dollar to remain unchanged. Some inflation is normal–most people factor in a rate of inflation between two and three percent when planning for their future income needs. But what if inflation is double or even three times the normal rate?

Inflation can be bad for a few types of people. Anyone on a fixed income or with a low annual income suffers as prices on goods and services increase faster than their income stream can keep up. People in loans with variable rates suffer during inflationary times because interest rates usually rise to combat high inflation. Many investors do very well during inflationary periods though. Here are some areas to consider for your investments if you think inflation is coming.

- Equities: Stocks usually perform well with inflation increasing. Companies can charge more for the things they make and earnings usually are excellent when prices are on the rise. Beginning in 1974, inflation started a 10 year period where it was much higher than normal and the stock market returns were positive during six of those ten years. Usually, there is some panic selling at early hints that inflation is coming, but staying invested will pay off in the long run. Sectors that do well during inflationary times include consumer staples, materials, industrials, and energy stocks.

- Fixed Income: Picking stocks is something that many people feel comfortable doing on their own, but knowing what types of bonds to buy if inflation starts to increase can be difficult. The most essential element to understand is that bond values and interest rates have an inverse relationship. If rates go up, which will happen to combat inflation, bond prices will fall, and long term bonds will see the biggest price decline. Staying short in your fixed income portfolio is the best bet right now, especially since the yields on long term bonds really aren’t all that attractive anyway. There are two types of bonds that can benefit from inflation. TIPS, or Treasury Inflation Protected Securities, offer a return that is based on the core inflation reading each year. Floaters, or floating rate bonds, have yields that are tied to interest rates and will increase as rates rise.

- Commodities: Many foundations and endowments managed by some of the smartest financial minds in the world are increasing their stakes in commodities as a way to hedge against inflation. Investing in oil, precious metals, and other commodities has been a good strategy in the past. Inflation usually causes the dollar to fall against other currencies. Many investors hoard gold, which has provided a nice return, but a diversified group of commodities is always a better bet. Silver, platinum, and other precious metals are less publicized but have vastly outperformed the performance of gold in 2009. There are several ETFs and mutual funds that are focused on commodities that offer professional management and diversification at a relatively low cost.

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Tags: commodities, equities, floaters, inflation, Investing, TIPS

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