Related topics: mutual funds, inflation, stocks, retirement, bonds
Are higher prices on the way? Or are they here already?
Statisticians are pointing to higher inflation, and the Labor Department reported that January marked the second straight month in which the Consumer Price Index had ticked up.
Higher food and gas prices pose problems for people from a quality-of-life standpoint, and they also spell trouble for investors. By the time you start tapping your portfolio to meet your income needs, those dollars you've managed to save could be worth a lot less than they are now.
That's why it's so important to ensure that your portfolio is adequately protected against inflation.
Some inflation-fighting vehicles have explicit protection against rising prices, such as Treasury Inflation-Protected Securities. Others, such as stocks, protect against inflation indirectly.
Here's an overview of the key vehicles with inflation-fighting attributes, as well as some of Morningstar's top picks within those groups.
Inflation-protected bonds
The Thesis: For holders of nominal (not inflation-protected) bonds, inflation is a natural enemy, right up there with rising interest rates. If an investment is delivering a fixed payout, inflation will reduce the value of that payout. That's where inflation-protected bonds come into play.
There are two main varieties: I-Bonds and inflation-protected bonds. The former are bonds for individual investors issued by the Treasury Department; their yields adjust upward to reflect changes in the Consumer Price Index.
Inflation-protected bonds, such as TIPS, are similar, but the inflation adjustment comes at the principal level, not in the bond's yield.
Best Bets: There are no funds composed of I-Bonds, but there are a number of offerings that focus on inflation-protected bonds. For plain-vanilla TIPS exposure, it's tough to beat the low-cost Vanguard Inflation-Protected Securities (VIPSX), iShares Barclays TIPS Bond (TIP) is a low-cost, no-nonsense choice.
The Pimco-managed Harbor Real Return (HARRX) has successfully employed a broader toolkit that encompasses non-U.S. inflation-protected bonds and the use of forward contracts to obtain TIPS exposure.
Bear in mind that when articles about inflation are splashed across every newspaper and financial website, TIPS can get expensive. Given that TIPS would also be susceptible to a rising-rate environment, anyone building a position in them should tiptoe for a period of months rather than quickly adding them to their holdings.
Bank loans
The Thesis: Unlike inflation-protected bonds, bank loans don't include an explicit mechanism to ward against inflation. But they stand to be fairly hardy when inflation is on the move. That's because bank-loan payouts fluctuate in line with the London Interbank Offered Rate -- the rate that banks charge one another to borrow money.
When the LIBOR heads up, which is often the case during inflationary environments, so do bank-loan coupon payments.
Best Bets: Bank-loan funds might seem to have everything you need for the current economic environment: imperviousness to rising interest rates plus some inflation-fighting characteristics. But investors should tread with caution in this varied category. Due to credit sensitivity and forced bank-loan selling from institutional investors, the average bank-loan fund lost a shocking 29% in 2008.
Morningstar's favorite fund here is one of the group's slow and steady options, Fidelity Floating Rate High Income (FFRHX), where manager Christine McConnell assiduously avoids the market's riskiest loans.
