Inflation Protection For Your Portfolio, Without Gold or TIPS

Posted by Adam Sharp - Friday, June 24th, 2011

Owning precious metals is more important than ever. Especially for Americans, whose purchasing power is strongly tied to the dollar. With so many dollars being printed, owning gold and silver makes sense.

But even the most extreme gold bug should have diversification in their portfolio. And some people simply aren't comfortable with gold. Nothing wrong with that.

But with global inflation picking up, the dollar in hospice, and growth slowing, preserving purchasing power should be on the front of every investor's mind.

Plopping cash into a savings account, or even a CD, seems like a pretty bad idea today. For example, if you park your cash in a BofA CD paying 1%, with real price inflation running more like 5-10%, you're screwed over any mid-long term horizon. That's simply unacceptable.

I'm basing the 5-10% inflation numbers off economist John Williams' alternate consumer price index (CPI) tracking shows the current US pace at around 10%. For more on his methodology, check his site.

shadowstats.com alternate inflation data

The purchasing power of low-yielding, dollar-denominated assets is likely to fall every year. In other words, when the CD matures and you get the principal back, that cash is going to buy less. Maybe a lot less. That's not good.

Foreign Bond Funds

One way to hedge exposure to the dollar is by owning foreign bonds. Interest rates aren't zero percent everywhere.

Government bonds in more fiscally-sound countries like Norway and Switzerland are still paying respectable interest rates. And their currencies have been trouncing the dollar, adding to profits.

The combination of higher interest rates and stronger currency performance of these assets make them a great hedge against the dollar.

Federated Prudent DollarBear fund (PSAFX) was designed this exact purpose (no affiliation). And it's performed remarkably well. $10k invested 10 years ago in PSAFX would be $22,150 today, according to Morning Star.

See this chart, where I compare the fund's performance to a vanguard Treasury Inflation-Protected securities fund (supposedly a good dollar hedge).

dollar hedge

Here's a description of the mutual fund, from the manager's site:

    * Pursues current income and capital appreciation.
    * Managed to provide a hedge against a declining U.S. dollar through investments that seek to perform in the inverse direction.
    * Focuses primarily on short-term foreign government bonds of developed countries; may also invest in securities-such as stocks of precious metal mining companies-linked to the price of gold.
    * Seeks to limit interest rate risk by maintaining a relatively short average portfolio maturity-generally less than 18 months.
    * Features a 10-year track record.

For American investors, the fund is a nice alternative to TIPS or CDs. I would assume that most countries have similar foreign-bond-heavy funds available.

It offers exposure to foreign govt bonds, which rise in value as the dollar falls. The fund's precious metal investments are an added bonus, and should continue to do well in an inflationary environment.

There are lots of good foreign bond funds out there. Pimco offers (PFAOX) a dollar-hedged foreign bond fund, for example.

Be SURE to check expenses. If your broker makes you pay 5% up front for the Federated fund, go elsewhere. There are C shares available of that fund, as well, which I believe are non-transaction fee.

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