How to Build an Inflation-Proof Portfolio

Obviously, no portfolio is inflation proof, but there are steps investors can take to ensure that their portfolio increases in price-value to keep up with inflation, at least. No tactic is fool proof, of course, and some work better than others. A few popular inflation hedges are a little over-hyped, while others can predictably beat at least the historical inflation rate.

• Income-Earning Investments. Investments that earn income, like TIPS and dividend-paying stocks are usually fantastic hedges against inflation so long as they pay interest at or above the current inflation rate.

• Farmland Investments. Farmland investments are a traditionally ever-growing industry — as long as the world population grows, so will their need for food. Because farmland is one of the most basic commodities, it is a favorite among those who have high commodity asset allocation in their portfolios as inflation hedges.

• Energy Investments.Energy investments, such as natural gas stocks and oil companies, are commonly used as hedges against inflation, much for the same reasons farmland is used (they’re commodity companies) and the income earning investments are used (energy companies pay high dividends).

• Gold and Silver. Gold and silver are probably the most popular forms of investing in preparation for inflation. Unfortunately, the popularity is often fueled by some misunderstandings. First, they don’t provide dividends. Second, they don’t necessarily always beat inflation — during times of prosperity they usually drop like golden rocks. Over the long haul of decades and decades, they tend to keep up with inflation, but in the short and medium term they’re still volatile.

• Cash-Oriented Strategies. This isn’t technically an inflation hedge, but more of a volatility hedge. The idea that cash (in the form of a money market fund or high yield savings account) is a good investment asset is trickier than the above strategies, but it’s closely linked to the income-earning hedge. Cash oriented investing is when you keep a portion of your portfolio in cash in order to have liquid assets that can easily be transferred into assets that are about to benefit from inflation/bubbles. For example, if you have 25% of your portfolio in cash and you just found out the Fed is going to create a substantial amount of new currency in the system, it’s a fairly safe bet that the stock market prices will be inflated in the near future — meaning you can turn that cash into profits.

• Permanent Portfolio. The permanent portfolio was made famous by Harry Browne several decades ago in his book “Fail Safe Investing.” The idea is fairly simple: if you have enough of your portfolio in the right assets, your portfolio should stay the same or rise consistently regardless of economic conditions, be they inflation, deflation, or prosperity. The idea has merit, though many claim he gave too much weight to precious metals in the portfolio. Either way, people who adhered to this philosophy have made a killing in the last few years.

In the end, inflation can destructive to those who don’t understand it, or extremely beneficial to those who do understand it. Like all market conditions, understanding the economics behind it can allow investors to position themselves to turn it into an asset in the long term rather than a liability.