LarryS

Investing to minimize inflationary effects

7 posts in this topic

Much to my chagrine, a close relative has recently converted ALL her investments to cash.

Isn't cash a terrible place to be in an inflationary period? Being as we're already underway inflation-wise, and given things are more likely to get worse than better (IMHO), what is a good strategy for someone in her position?

She is just at retirement age (66) and in good health, so mitigating volatility is a priority on-par with preserving purchasing power.

I'm thinking short bonds, short CDs and precious metals are probably the best value-preservers, but I wonder about real estate, commodities, even stock index funds as they all strike me as more inflation-resistant and thus safer for the next several years than cash.

Any insights or advice regarding good asset classes, and how to time moving funds into them (evenly over a year or two, one big up-front move, etc.)?

--Larry

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Much to my chagrine, a close relative has recently converted ALL her investments to cash.

Isn't cash a terrible place to be in an inflationary period?

Cash has a big advantage: liquidity. It allows you to make quick moves when an opportunity arises such as closing an all-cash deal on some seriously under-valued real-estate, sending your money to a more investment friendly country, etc.

Being as we're already underway inflation-wise, and given things are more likely to get worse than better (IMHO), what is a good strategy for someone in her position?

She is just at retirement age (66) and in good health, so mitigating volatility is a priority on-par with preserving purchasing power.

Absolutely!

I'm thinking short bonds,

That's a bad idea unless you are talking about bonds that will mature in a few months and have an active market. Bonds are paying very little right now and someone can lose a lot of their equity in the very likely event that interest rates go up. The value of the bond will go down to compensate.

short CDs

One year CDs are only paying 1.25%. That isn't much and, in my opinion, doesn't compensate for the loss of liquidity. A lot can happen inflation-wise and otherwise in a year.

and precious metals are probably the best value-preservers,

I'm doing serious trading in gold, but it is not for people who don't know what they are doing. Also, I would recommend trading investments, as much as possible, within a Roth IRA account. That way, the gains that might keep her even with inflation won't end up being taxed as "income."

but I wonder about real estate, commodities, even stock index funds as they all strike me as more inflation-resistant and thus safer for the next several years than cash.

Since she has to live somewhere, she can hold the line on housing costs by owning the place where she lives. In times of inflation, it pays to be a debtor and, especially now with interest rates so low, I recommend getting the biggest 30-year, fixed-rate mortgage at the lowest rate possible. If she has a mortgage, she should look into refinancing. Stocks and commodities, like precious metals, are risky, so she should know what she is doing and only put a small portion of her assets in them and, preferably, in a Roth account.

Any insights or advice regarding good asset classes, and how to time moving funds into them (evenly over a year or two, one big up-front move, etc.)?

A good idea is to start by investing by proportions and trade to maintain them. For instance, she might use the rule of 100, take her age (66), and keep 66% of her assets in cash or equivalents like money market funds. The rest might go 1/2 into gold and 1/2 into an S&P 500 fund.

She can also get as much as 25% extra income on her investments by buying exchange traded funds (ETFs) and writing covered calls on them. The gold ETF is GLD and the S&P 500 ETF is SPY and both have active markets in their options. But, again, this is only for someone who knows what they are doing and will watch it on a daily basis.

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Don't forget silver. Take your cash to a local coin shop, and ask for circulated U.S. coins (1964 or before), called "junk silver" by some. They are 90% silver.

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Don't forget silver. Take your cash to a local coin shop, and ask for circulated U.S. coins (1964 or before), called "junk silver" by some. They are 90% silver.

I regard silver as "emergency money" to spend for living expenses if everything goes to hell. The small denominations make silver coins easy to use for food and other daily necessities, and the form of coins makes them recognizable, negotiable, and easy to store at home.

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Thank you for the insights, Betsy.

One bit of advice that caught me off guard was for the high-percentage cash position. Originally I thought cash would be unappealing, since even 3% inflation basically results in a 3% loss in purchasing power each year. How would one stay ahead of inflation while holding a lot of cash? Would money markets adjust fairly quickly to inflationary pressures?

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One bit of advice that caught me off guard was for the high-percentage cash position. Originally I thought cash would be unappealing, since even 3% inflation basically results in a 3% loss in purchasing power each year. How would one stay ahead of inflation while holding a lot of cash? Would money markets adjust fairly quickly to inflationary pressures?

Ordinarily, interest rates paid by money market funds would rise to compensate for inflation, but the Fed has kept interest rates near zero. Bernanke says there will not be a QE3, so interest rates may skyrocket and money market yields will do likewise.

The main reason for recommending the 66% (based on her age) in cash or money market funds is preservation of capital and liquidity. The whole idea of putting an age-based percentage of one's assets in "safe" investments is that, the older one gets, the fewer years one has to recoup investment losses with one's earnings from work, so capital preservation becomes an important consideration. Ordinarily, bonds and CDs would be considered safe investments, but these are not ordinary times. Bonds are yielding close to zero return and we may be about to experience a sharp and sudden rise in interest rates. That is bad news for the value of any but the shortest term bonds. As for CDs, I don't think a 1.25% return at all compensates for the likely even of 5-10% inflation and the loss of liquidity for a year.

There is so much downside pressure on the economy and so much uncertainty, that the best policy is to keep one's options open as much as possible. That is why cash or money market funds make the most sense for one's safe money.

One thing I didn't mention are some basics a woman in her situation ought to cover before making any investments at all. In addition to securing her living arrangements with a long-term fixed mortgage, she should have liability insurance to protect her assets against lawsuits. She should have an "umbrella" policy for anything over and above the liability coverage of her home and car insurance and she can get several million dollars in coverage for just a few hundred dollars a year. Also important is long-term care insurance to protect her from the asset-depleting costs of medical care for debilitating conditions she might acquire. A good long-term care policy is expensive, but can be totally tax deductible as a medical expense.

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Well said Betsy.

I have been going back to school to study financial planning. I'm mad at myself for getting an A- in my first class (Financial Analysis). Started my second class last night. I'm really enjoying it. I'm actually interviewing with a financial company today; second interview. I hope to work in financial planning in the evenings while keeping my engineering day job as my foundation for at least a while. I expect to be sleep-deprived.

One subject worthy of another thread is that of fiduciary vs. suitability in financial planning. Is anybody familiar with that? They are very different approaches.

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