Is Increased Inflation on the Horizon?

This is an excerpt from an article we sent to our clients from S&P Capital IQ Financial Communications.

Economists and market watchers have been warning investors about the prospect of increased inflation for several years as ample liquidity has been injected by the Federal Reserve.  Worries about inflation may crop up should commodity prices push up consumer prices, both in the United States and abroad. With an improving economy and soaring federal deficits, many experts feel that prices in the United States will inevitably pick up their pace.

Staying Ahead -- For investors, staying ahead of inflation means choosing investments that are most likely to provide returns that outpace it. Climbing inflation rates could impact various investment types and asset classes; some are listed below.

Domestic Stocks -- Although past performance is no guarantee of future returns, historically, stocks have provided the best long-term returns that exceed inflation. An analysis of holding periods between 1926 and December 31, 2011, found that the annualized return for a portfolio composed exclusively of stocks in Standard & Poor's Composite Index of 500 Stocks was 9.83% -- well above
the average inflation rate of 2.99% for that time period. However, over shorter
time spans the results are less attractive. For the 10 years ended December 31, 2011, the S&P 500 returned an average of only 2.92%, compared with an average inflation rate of 2.50%.[2]

International Stocks -- During the same 10-years ending December 31, 2011, the Morgan Stanley Capital International (MSCI) EAFE, composed of established economies such as Germany and Japan, outpaced U.S. inflation with an average return of 5.12%. The MSCI Emerging Markets index, which tracks developing world economies such as Brazil and China, was even more stellar, returning an average of 14.2%.[3]

Bonds -- Historically, investors have turned to shorter-term corporate and high-yield bonds for protection in rising-rate environments.[4] There are two types of bonds that receive a lot of investor interest when inflation starts to rise: Treasury Inflation-Protected Securities (TIPS) and I Savings Bonds. Both TIPS and I bonds are types of fixed-interest rate bonds whose values rise as inflation rates rise.

CDs and Other Cash Instruments -- The Federal Reserve is still keeping interest rates low, forcing investors who hope to keep pace with inflation by investing in cash instruments facing a harsh reality. The rates on a one-year CD are averaging under well under 1%, while a five-year CD is also yielding an average of well under 2%, according to Bankrate.com.[5]

Although many economists project overall U.S. inflation to remain low in the near
future, most see an uptick down the road. For investors, a well-rounded portfolio may be your best weapon. The key is to consider your time frame, your anticipated income needs, and how much volatility you are willing to accept, and then construct a portfolio with the mix of investments that you are comfortable with. Consult your financial professional to discuss your specific needs and options. 

We are happy to discuss this and any other investment or financial planning
questions that  you have.  See our website for more timely research at
www.regencywealth.com. 

[1] Source: U.S. Bureau of Labor Statistics, January 2012.

[2] Sources: TradingEconomics.com; U.S. Bureau of Labor Statistics, January 2013

[3] Source: Morgan Stanley. The MSCI EAFE and MSCI EM are unmanaged indexes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

[4] Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.

[5] Source: Bankrate.com, January 20, 2012.

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