Monday May 19, 2008
Inflation-Offset Investments
Inflation-Offset Investments
Count on it — inflation is rising sharply and will continue to do so.
According to the U.S. Bureau of Labor Statistics, inflation for the first four months of 2008 amounted to only 0.9%. That’s an annualized 2.7% rate of inflation. But as most of us realize at the gas pump and supermarket checkout counter, that low number is wishful thinking. Here are the facts.
The Bureau of Labor Statistics compiles our country’s official inflation statistics. It collects data on a basket of goods, “tweaks” or adjusts the data for statistical accuracy, then tabulates the increases in its “Consumer Price Index”, the government’s official measure of inflation. In its last tally, the Bureau reported that the price of gas — one of the many components of the CPI — actually fell 2 percent in April.
Not surprisingly, the report befuddled consumers and economists alike. According to The New York Times:
“For April, [the Bureau reported that] energy prices were unchanged and gasoline prices even fell by 2 percent, a decline that would strike motorists as strange, given that they have been watching the price of gasoline rise relentlessly in recent weeks. …Since gas prices normally rise in April, the 5.6 percent increase in gasoline prices [reported] for the month was turned into a 2 percent drop after the government adjusted for normal seasonal variations…”
Of course, the obvious question is: Why do we need “seasonal adjustments” at all? Why not simply compare April ’08 with April ’07 numbers?
We do need adjustments to align 1970s and 1980s inflation data with contemporary statistics since the government has periodically changed the way inflation is tabulated. But once we compare “apples” with “apples”, no consumer will agree that gas prices are dropping!
In fact, 90% of Americans in a recent CNN poll said they are concerned about inflation. And the same Times article found that the average price of gas had climbed to a then-record $3.75 a gallon nationwide by May 8th — “up nearly 40 cents in the past month.”
That’s a 12.7% increase in just one month according to my pocket calculator. (But — I admit with a grin — without any “seasonal adjustment”.)
Many of you may agree that the government’s Alice-in-Wonderland tabulations of inflation are far off the mark. Officially, inflation was only 4.1% in 2007. (It felt like a lot more to me!) And this year the picture is even rosier because the Consumer Price Index for all urban consumers is officially showing a mere 0.9 percent increase for the first four months of the year — that’s right, less that one percent thus far — when “seasonally adjusted”.
Right. And I know of a great bridge in Brooklyn that you can buy dirt cheap, too.
More and more analysts tabulate much higher rates of inflation. One interesting (and for-pay) website worth checking out is www.shadowstats.com. Its inflation statistics are sometimes debatable, but much more realistic and sobering. Check out its findings and estimates of the country’s substantially higher inflation.
I also respect the views of Daryl Montgomery, a former professor and one of the organizers and periodic speakers at “Investing MeetUp” in New York. His “Investing MeetUp” group is an outstanding forum where lay investors and seasoned investment professionals meet once a month to discuss investment topics and trends.
Inflation is a serious concern and frequent topic for the group.
According to Montgomery, statistical adjustments are, indeed, required to compare inflation figures over time since the methods for tabulating inflation have changed periodically. “Taking away all the changes made to inflation calculations in the last 25 years,” he says, “you find that our current inflation rate is about 12%, close to the high 14% in 1980.”
If you happen to live in or visit New York, I strongly encourage you to join an “Investing MeetUp” session. You can check the group’s website [http://investing.meetup.com/21] for the times and dates of meetings as well as for podcasts of prior presentations. It’s a great way to expand your financial education.
My own belief is that inflation is large, growing, and becoming a serious threat. I agree with the views of Dr. Rob Arnott, the respected economist and index expert, who said in a 2004 Forbes interview:
“I’m a little pessimistic on inflation. I see four risks. Monetary policy is aggressively expansionary. Fiscal policy is aggressively expansionary; the deficit spending is pretty aggressive. And last but by no means least, demographics — the pending retirement of the baby boomers, who will want to buy goods and services that they no longer produce — is putting upward pressure on prices of goods and services.”
Since Dr. Arnott offered those remarks, interest rates have been pushed lower and lower, the federal debt has soared, and the nation’s money supply has been significantly increased — all highly inflationary stimuli.
So where does this leave investors? What kinds of investments might protect you from the debilitating effect of inflation’s harm?
In my book Cash-Rich Retirement, I encourage investors to buy TIPS [“Treasury Inflation-Protected Securities”] provided you hold them in a 401(k), 457(b), IRA, variable annuity, or some other tax sheltered account. I specifically urge readers to hold about 10% of their savings in TIPS funds. But, I repeat, only hold them in a tax-sheltered account to avoid taxes when adjustments are made for inflation.
There are several excellent TIPS funds you can look into. I happen to like: (1) Fidelity’s Inflation-Protected Bond Fund [FINPX], (2) Vanguard’s Inflation-Protected Securities Fund [VIPSX], (3) TIAA-CREF’s Inflation-Linked Bond Fund [TCILX], and (4) iShares TIPS Bond ETF [TIP], an exchange traded fund with low cost features.
Investing in TIPS via funds or an ETF can be helpful. Since these funds primarily invest in U.S. securities, however, the Bureau of Labor’s CPI numbers are used to adjust the principle and interest payments of these bonds. That will give you periodic, but understated adjustments for inflation. Even so, some offset is better than none.
Two other kinds of “inflation-offset” investments are worth looking into as well.
A number of foreign governments also issue inflation-protected bonds — e.g. Britain, Germany, France, Canada, Australia, Greece, and others. In the past it has not been easy to buy a fund containing such securities. Some U.S. TIPS funds do reserve the right of invest up to 20% of your money in non-U.S. inflation-protected securities. But that still means you’re primarily getting U.S. exposure and loops you back to the CPI accuracy and understatement issue.
A new ETF [exchange traded fund] was just launched last week that invests in a broad mix of the inflation-protected securities of only foreign-government issuers. That fund is the SPDR Series Trust ETF International Government Inflation-Protected Bond Fund [WIP].
It puts your money into the “protected” bonds of some 16 countries other than the U.S. No single bond represents more than 5% of total outstandings. And the rates of interest of many of these foreign bonds are substantially better than their U.S. counterparts. So it’s a good ETF to keep an eye on — even if offshore inflation rates are different than our own.
Gold is also a good inflation hedge. Research shows that the price of gold tends to move up with inflation and often in advance of inflation. Gold happens to be an excellent “advance forecaster” of stronger inflation. Since the price of gold has shot up a whopping 38% since the beginning of 2007, we may be headed much higher inflation soon (with, indeed, some gold correction).
Even if gold prices cool, however, the long-term prospects for precious metals are still favorable. Global demographics favor precious metals as well. I explain this in my book, encouraging readers to put about 5% of their savings in gold or precious metals funds.
There are a number of good funds to choose from. I particularly like Fidelity Select Gold [FSAGX] and Vanguard Precious Metals [VGPMX]. You can use free on-line research to learn more about them and obtain a prospectus.
For the record, I happen to invest in all of the funds and ETFs cited above. I like their content, risk characteristics, and management. However, you should do your own homework to determine whether these investments are suitable for you.
Whatever your reaction to precious metals and inflation-protected bonds, it’s time to strengthen your positions in investments that can withstand inflation. If you believe in the Bureau of Labor’s numbers and think inflation is low, demographic pressures are nevertheless building which — as I explain in Cash-Rich Retirement — should add to the attractiveness of these kinds of investments. But count on inflation building more and more power ahead.
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