How to wage your own war on inflation

Another inflation-protecting option is to invest in a broader basket of diversified commodity index-linked securities.  Such "baskets" of securities would include gold, but also provide exposure to the commodities contributing to the inflation like crude oil, natural gas, soybeans, cotton, and even silver. 

“This provides more balanced protection against price risks,” says Harris, whose firm oversees one of the biggest of these baskets, the PIMCO CommodityRealReturn Strategy Fund. Additionally, several ETFs, which create similar index-linked exposure have recently debuted.  These include Deutsche Bank’s DB Commodity Index Tracking Fund and Barclays Bank’s iPath series of exchange traded notes.

EverBank also offers a CD tied to various currencies from commodity-dependent countries for those wishing to take the guaranteed principal approach. These CDs, however, require minimum deposits of $20,000.

Bonds seen as the best inflation hedge
While such commodity baskets offer inflation protection when commodities are in bull market mode, the most direct way of addressing inflationary concerns is by buying inflation-indexed bonds.

The U.S. Treasury issues two types of bonds directly linked to inflation.  Its Series I Savings Bonds may be purchased at no cost through TreasuryDirect, or at any bank, in denominations as low as $25 when purchased online.  They pay earnings on a deferred basis so they are not taxable until they are cashed in, and at that point they remain free of state income taxes. 

Also available through TreasuryDirect are Treasury Inflation-Protected Securities  (TIPS).  There are also a number of mutual funds that own TIPS — easily identified by the words ‘inflation’ or ‘real return’ in their titles.  There is also an ETF, the iShares Lehman TIPS Fund.  The advantage of these funds is that they offer greater liquidity and greater diversification in terms of maturities.

The true attraction of TIPS is that they offer a direct hedge to inflation with far less volatility than gold or commodities.  That they are direct obligations of the U.S. government makes them the perfect fit for risk-adverse investors.

Harris offers one other inflation-sensitive asset appropriate for individuals — it is one hat many already own — real estate. This is why regardless of whether or not individuals choose to add inflation protection to their investment portfolio — or how they choose to do it — they need not go to extremes. Their largest investment, their homes, already gives them exposure to an inflation-sensitive investment.  This is also why Harris, like other advisors, recommends no more than 5-to-20 percent of a securities portfolio be devoted to inflation-protecting investments — a little bit can go along way toward insuring that invested assets retain their purchasing power over time.

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