Inflation

Inflation is the nine letter dirty word that looms large in the fears of many these days. Those who remember the 1970s do so with a chill recounting tales and horrifying the younger generation that can't quite fathom how prices can vary on ordinary household needs. If inflation is headed our way soon, the question becomes how best to prepare for it. 

Inflation is a government-created problem that every government thinks it can control.  However, it has meant the end for several governments world-wide over the past two centuries.  As we try to build wealth for ourselves that will provide for our future benefit, we must keep in mind that saving up a slew of greenbacks may not work out as well over time as we planned if significant inflation were to occur in the near future. 

Traditional financial planning has suggested that one of the best ways to protect yourself against the ravages of future inflation is through the purchase of Treasury Inflation-Protection Securities (TIPS).  TIPS is a government security sold by the U.S. Treasury Department and is tied to the Consumer Price Index (CPI).  TIPS pays interest at a fixed rate twice each year.  The principal balance you loan to the government is adjusted based upon an increase or decrease in the CPI; i.e., it goes up with inflation and goes down with deflation.  At maturity you receive the greater of the adjusted principal or what you originally loaned to the government. 

One problem with TIPS that should be kept in perspective is that TIPS has not been tested in a period of heavy inflation. They have only been offered since 1997.  Moreover, as TIPS is a government security based on a government index, there could be pressure to artificially keep the CPI lower than it naturally should be.  In fact, many people already believe the CPI is kept unnaturally low. 

Another way to hedge your bets with respect to the coming inflation is to invest in gold and silver (other commodities can accomplish this goal as well, see article on commodities).  While traditional financial planning tends to downplay investments in precious metals, we would strongly argue that these commodities have been time tested as real inflation hedges.  People will always recognize gold and silver as having intrinsic value.  Accordingly, when inflation rears its ugly head, these metals will naturally become more desirable.  Gold and silver have long been perceived as real money when people cannot rely or believe in their government’s currency. 

In the final analysis, when you survey your options vis-à-vis the prospect of a coming inflationary period, you should diversify your options as much as possible.  In this vein, an investment in a TIPS, even though this investment is far from foolproof, might be a good idea.  Balance this with an investment in gold.  You should also strongly consider diversifying some funds into silver. For more information on investments in gold and silver see our article on the topic.