Inflation can be a nasty surprise for investors who are not amply prepared. Its effects can reduce your real return on an annual basis and make it much more difficult to keep up with your standard of living. With the newly announced open-ended quantitative easing program that involves a fair amount of money printing, many investors are worried that it is only a matter of time before inflation kicks up and wreaks havoc on their investments. Some are predicting hyperinflation, while others like Bill Gross have stated that inflation will be significant enough to turn all real returns to 0% for the foreseeable future.
No one can say for sure where inflation will be tomorrow, and perhaps the bigger issue is that most people cannot say what it is today. Typically, the CPI from government statistics is used as a gauge for measuring the effects of inflation, but recent years have seen investors and consumers lose faith in that stat. The numbers always seem to be conveniently below 2%; right where Bernanke and the Fed need to keep them in order to justify their QE program and low interest rates. But anyone who has been to a supermarket in the past few years knows that prices have been outpacing that paltry 2% figure.
Now comes the tough part, if you can’t look at the government statistic, where are you supposed to go to find out what inflation actually is? There is no single measure that stands out as the “best” or most used, but there are plenty of alternative ways to measuring the general rise in prices around the nation. Below, we offer three different methods of measuring the impact of inflation so you can better protect you portfolio.
Shadow stats is one of the most popular methods out there for measuring inflation, as their SGS varieties present a number of insightful findings. “Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that neither reflects the constant-standard-of-living concept nor measures adequately most of what consumers view as out-of-pocket expenditures” says Shadowstats in refence to why they created their own inflation index. This index follows the metrics which were used to calculate inflation between 1980 and 1990 to give what this site feels is a much more accurate depiction. Unfortunately, that depiction shows inflation at nearly 5%, more than double of what the government has reported.
If that statistic gave you cause for concern, the pre-1980 method for measuring price increases may make your stomach turn. You can read more about how this index was built here, but its old-school method of computing certainly yields a different result. This index finds inflation to be sitting around 8% as the delta between standard CPI and SGS only grow as the years go on.
Gold to Equity Benchmarks
This has long been another popular measure of inflation, as many people consider gold to be a real money and that it is the only true way to measure inflation. You can use either the Dow or the S&P 500 and chart how many ounces of gold they could buy, and the results are a bit disturbing. Despite which index you use, this ratio shows a decrease of 80% in the last decade or so. While this method does not necessarily yield you with a specified percentage, it shows how gold has outpaced equities, which many feel is a direct result of inflation.
How to Fight Inflation
Commodities have long been one of the best asset classes for keeping up with inflation, as owning these real assets will allow you to keep a lock-step with price rises. Of course, it is unlikely that these assets will outpace all inflationary environments, but dedicating 5% to 10% of your portfolio to commodities will be a great way to make sure inflation does not get the best of you. For long-term exposure, exchange traded funds present the most appealing option, as a number of these products invest in futures baskets to help you gain easy access to hard-to-reach commodities. Funds like the DB Agriculture Fund (DBA) and DB Commodity Index Tracking Fund (DBC) are two of the most popular options out there, but there are plenty of other funds that extend out to deeper corners of the hard asset space.
Disclosure: No positions at time of writing.
Disclaimer: Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.