Vaccinate against inflation: Take steps to keep your financial portfolio healthy

October 1, 2008

Inflation reminds me of termites: It gradually eats away from the inside of your financial portfolio - unnoticed and silent. Left alone, it can cause major structural damage, even total collapse.

Inflation reminds me of termites: It gradually eats away from the inside of your financial portfolio - unnoticed and silent. Left alone, it can cause major structural damage, even total collapse.

Whether the harbor lights are already coming into view or your retirement is still years away, you need to keep inflation in mind, especially in today's volatile environment. Many financial experts are predicting a round of serious inflation over the next few years.

It's unlikely that we'll be battling the double-digit inflation of the 1979 to 1981 years, when the rate reached a high of 13.58 percent. Still, even a minor increase in recent figures can cause serious financial pain - unless you take steps to protect yourself.

Whether your portfolio is smaller or larger, ignoring inflation will weaken your financial future to the same extent. With life expectancy on a rising curve and costs skyrocketing for such essentials as food and energy, making your money last longer than you do is becoming a serious challenge.

Stocks

There's no absolute vaccination against inflation, of course, but almost without exception, financial advisers say every portfolio must include investments in stocks.

Historically, over almost any extended period, stocks have provided a better total return than any other form of investment. Since 1925, the Standard & Poor's 500-stock index averaged a gain of 10.4 percent a year, easily outperforming the 5.3 percent annual return for intermediate-term government bonds.

That's why I agree with the need for equities in every portfolio, but I can't say that I agree with the 60 percent (and in some cases, more) proportion recommended by some advisers. While a 60 percent investment in stocks may be fine for someone with at least a decade or two before retirement, it would be too risky for someone nearing or already in retirement.

While stocks have the best chance of achieving high returns over the long term, it's important to emphasize that these are, indeed, long-term investments. If you've been dabbling in the investment world for a time, you know that short-term periods for stocks can be disastrous.

Thus, the ratio best for you depends on factors such as your age, how long before planned retirement, and your personal tolerance for risk.

Even for a person in full retirement, I would suggest a minimum of 20 percent invested in stocks to keep your head above inflation's tricky waters.

With stocks making up a respectable percentage of every portfolio, the importance of picking the right stocks is evident. In my view, choosing individual stocks from among the thousands available on American and foreign exchanges simply isn't practical for the typical investor.

What's more, slogging through an endless stream of annual reports, prospectuses, stock tables and other arcane statistics might drive some people to the edge of madness. If that kind of punishment is not for you, forget about investing in individual stocks.

Mutual funds

Do your equity investing in mutual funds. Let experts who are paid to absorb all that punishment decide which stocks to buy.

With more than 10,000 mutual funds to choose from, there are funds available to suit almost any taste. The major fund families, such as Vanguard, Fidelity and others, offer funds designed to suit individual goals.

You can buy funds that seek safety of principal, steady dividends, high growth, or growth and income. There are funds that are restricted to equities in emerging markets or market sectors. Sector funds invest in one particular sector of the economy, such as technology, banking, computers or the Internet.

In short, you can find a combination of mutual funds designed to satisfy your objectives, whatever they may be.

When you buy a mutual fund, you get instant holdings in a large number of different companies. That's an important form of diversification, and it provides you with a significant level of stability in your investment.

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