NEW YORK - The global recession had largely muzzled inflation's bite, but actions being taken to cure the developed world's economic ills could revive threats to bond investors and savers and spoil many Americans' retirement plans.
Record levels of government spending in Europe and the U.S. to prop up flagging economies are seen by many as a recipe for inflation - Public Enemy No. 1 of bond holders and bank accounts. High inflation hurts savings-oriented strategies because rising prices erode consumers' purchasing power, and consequent interest-rate hikes slam fixed-income investments.
"Keeping your assets in cash isn't going to get it done for you, because they won't be able to hold their value when there's inflation," said James Shelton, chief investment officer of Kanaly Trust in Houston.
Yet savers don't have to wait for the inflation torpedo to hit. Some effective strategies can hedge against rising prices and even take advantage of an inflationary environment.
For example, investors lately have been saying "auf wiedersehen" to the euro and "good day" to gold, which is a traditional hedge against inflation.
Many investors are alarmed that the European Union's attempt to rescue Greece and other Mediterranean countries from default, coupled with massive stimulus spending in the U.S., is flooding the global financial system with money and will stoke inflation, kick up interest rates, further weaken the euro and, ultimately, strain the U.S. dollar.
Bond-fund giant Pimco is among the powerful voices raising concern that inflationary pressures could build over the next three to five years.
"(We) could witness the impact of increasing monetization of debt, gradually rising inflation rates and a worsening of inflationary expectations," noted Mohamed El-Erian, Pimco's co-chief investment officer, in a global markets outlook published on May 12.
Under those circumstances, one highly effective way to inflation-proof your portfolio would be to buy Treasury Inflation Protected Securities, or TIPS, government-backed bonds that are linked to inflation. So-called real assets such as gold or other commodities, whose returns are historically pegged to rising prices, also would be attractive.
"TIPS tend to be very steady, whereas gold has a lot more volatility," said Chris Hobart, chief executive of Charlotte, N.C.-based Hobart Financial Group. Hobart's firm manages money for individuals who are mostly between the ages of 55 and 75. He said he's already talking about inflation with his clients.
Hobart said he also recommends owning shares of companies that stand to benefit from rising prices, such as those in the oil and gas, food and health care sectors.
Shelton of Kanaly Trust, which manages about $2 billion in assets, echoed Hobart's approach.
"Real assets (such as commodities and housing) are the only thing that will hold value if there's inflation," he said.
Beyond the markets, there are other ways to take advantage of rising prices. People should, for example, think about remortgaging their house, said Laurence Kotlikoff, an economics professor at Boston University.
"It's generally a good idea to pay down a mortgage as soon as possible," he said. "But a long-term mortgage can be a good hedge against inflation because the real value of repayments will decline."
Kotlikoff said he'd then invest the extra money in TIPS.
Another strategy to whip inflation is to make the most of rising interest rates by "laddering" a bond portfolio. In this way, interest-rate risk is spread across short-, medium- and long-term bonds, allowing investors to reinvest at higher prevailing rates as bonds mature.
Hobart said he's not looking at bond ladders today, but added that as interest rates rise, the strategy will become "a more viable option."
"When you have higher rates, there's no need for retirees to head into riskier assets to generate returns," he said.
Those heading toward retirement should also keep in mind their Social Security checks. For one thing Social Security income is linked to inflation. But thinking strategically about when to start payouts makes a big difference.
For example, delaying when the checks are claimed can boost income - making a first claim at 70 years old rather than at age 62 means the payout will be about 75 percent higher, Kotlikoff said.
"People should do everything they possibly can to wait until they're 70 to collect retirement," he added.
That means working longer - a rising trend that more people should embrace, say retirement experts.
Steve Utkas, who oversees Vanguard Group's Center for Retirement Research, cited a study that found 21 percent of Americans age 70 to 74 were working in 2007, compared to 15 percent 20 years earlier. He noted that more than half of households of people in their 60s were earning income from work.
The benefit is twofold - money comes in and nest eggs remain untouched - and can make a meaningful difference in lifestyle: one study found that delaying retirement by three years can halve any shortfall in savings that a retiree faces.
Kanaly Trust's Shelton said that the threat of inflation has steered him towards assets that can provide generous cash flows, such as energy master limited partnerships. These products have assets in energy industry infrastructure, such as pipelines. Not only would the sector rise with inflation, but the energy MLPs have high yields - recently in the 7 percent range.
Another income-generating product is an annuity, which offers guaranteed income in exchange for a lump sum paid upfront. Perhaps prompted by uncertain markets, use of annuities and similar products is on the rise: a study by Cerulli Associates found that almost one-third of financial advisers increased their use of guaranteed income streams last year.
With the fear of looming inflation, it may be wise to invest in inflation-linked annuities rather than traditional fixed annuities. But as John Ameriks, head of Vanguard's investment counseling and research group, noted, because inflation-linked annuities are built to increase payments as the years pass, their initial payouts are smaller than those of their traditional counterparts.
Ameriks also said that while TIPS can help lessen the ravages of rising prices, there's a chance there'll be inflation shocks in the future - unexpected jumps in the rate of inflation - and ordinary money-market funds would help in such a situation. It's likely the Federal Reserve would respond to such a shock by raising short-term interest rates, a move from which the biggest beneficiaries would be money-market funds.
One popular investment product may face problems in a world of rising inflation and rising interest rates: target-date retirement funds. These funds usually start heavily tilted in stocks but as they near maturity - on or around an investor's retirement age - they rotate more into bonds. The timing of when that happens could be crucial.
"If interest rates are climbing, then it becomes harder to make money in bonds and investors need to look closely at their target-date funds to see what their bond exposure is," said Jim Hardesty, chairman of Hardesty Capital Management in Baltimore, which runs about $800 million. "The question is will these funds be more proactive about dodging the bond bubble than they were about avoiding the 2008 market dive."
Many target-date funds surprised investors with their poor performance in late 2008 in part because their stock allocations were high.
Ameriks also sounded a note of caution against a strategy geared solely towards beating inflation. For instance, he said that long-term returns suggest that real assets typically match inflation but don't outpace it, and while bond ladders can work if rates are high enough, they aren't particularly liquid.
Ameriks added that if inflation doesn't rise significantly, TIPS will provide lower returns than most other bond offerings.
"There's a danger in focusing too much on one particular risk," he said.
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