Protect Against Inflation With ETFs

by: Paul Nathan

There is continual debate by the average lay investor over what the real rate of inflation is. Professionals look at many indexes: the Consumer Price Index or CPI; the Producer Price Index or PPI; the core CPI and PPI, which excludes food and energy; and some rely on entirely different measurements altogether, such as the GDP Deflator. Obviously, each of these methods of measuring inflation provides different results -- some indicating much higher or lower inflation than others. So how can anyone determine the "real" rate of inflation and how important is it to us as investors?

Calculating the "rate" of inflation matters a lot to government officials and economists. After all, mortgage rates, social security payments, GDP estimates, and many labor contracts are tied to it. But to the average person, these are just technical numbers and the official rate of inflation actually matters very little. What does matter to each of us, however, is our own personal cost of living. That is our personal inflation rate.

What it costs to live depends on a lot of individual factors. The transportation costs of a person that walks to work, takes the bus, or bikes, will be different than someone who commutes by car. The cost of heat in winter can vary a lot, depending on the weather. Some have large families and education expenses to worry about; others have young careers that have them eating most of their meals in restaurants; while some who are older require prescriptions and constant visits to the doctor. And big consumers of electronic gadgets are asking, "What inflation?" since every year, the quality of electronics goes up as the prices go down. Different lifestyles incur different "inflation rates."

Another big factor in our personal rate of inflation is what we do for work. Most general contractors, builders, construction workers, real-estate agents, appraisers and mortgage lenders have lived in a world of deflation over the last several years. The price of what they sell has been going down together with their incomes. In contrast, many who work in the export industry, agriculture, or energy currently inhabit a booming inflationary world where dramatic price increases and unemployment in the low 3-4% range are routine. So whether we are personally experiencing "inflation" or "deflation" can also have a lot to do with where we live and work.

That's not the number economists are after when they calculate inflation. They are charged with figuring out what is going on with prices in the economy as a whole. Economists also realize that prices going up in one area means prices must fall in another. There simply can't be "gasoline inflation" without consumers spending less money somewhere else. How could there be "food inflation" without prices falling on some other goods? In any evenly rotating economy, some prices are going up as others fall. Increasing and decreasing prices in a market economy is normal. It is only when we have persistent increases in money supply chasing less goods that we get progressive across the board increases in prices.

Yet with all the current talk about inflation, some may not realize that there hasn't been a significant across the board increase in inflation in 30 years. In fact, the CPI has fallen from rates of 13% in 1981 to under 2% today in what could be described as a period of progressive disinflation.

Some argue that's because the indexes measuring inflation are wrong. I have news for these folks. The indexes are always wrong. No matter which index you use, it must be wrong by its nature. An index cannot accurately measure the trillions of prices and their cross relationships, even for a single moment in time. Indexes are theoretical and work for economists who need a yardstick to compare different types of goods, services, weightings, and compensations. These indexes are subjective. You might as well explain to a man standing in 14 feet of water that the average depth of the lake is five feet. As I just pointed out, personal reality is very different from theory.

But the increases or decreases in the prices we pay for goods and the services we need are not subjective or theoretical. They are real. While economists talk about the rate of inflation, the immediate threats to most people are high gas prices, high food prices, high medical costs, or any specific price trend (higher or lower) that personally affects one's cost or standard of living.

Fortunately, there are ways to protect ourselves based on our individual price vulnerabilities. Gold and silver is one way to do this. Since gold was unfixed from the dollar at $35 an ounce in 1971, it has risen to as high as $1900 an ounce. That is certainly sufficient to compensate for any rise in prices.

But there is another, perhaps even more direct, way to protect ourselves -- ETFs. Exchange Traded Funds are indexes created to track markets or segments of the economy. And they make it possible for investors to slice and dice up industries and sectors, hedging against potential price increases or decreases that would impact their personal cost of living. Done right, we can now customize our own "personal inflation protection portfolio" using ETFs. For example, if you drive a lot and the price of gas is killing you, buy (NYSEARCA:UGA), an index tied to gasoline that will increase with the price of fuel. If food costs are your nemesis, buy (NYSEARCA:MOO), which will yield returns as food goes higher. In healthcare there is (NYSEARCA:XLV), and in housing (NYSEARCA:IYR). Both will put money in your pockets if health or housing prices increase.

Inverse ETFs such as (NYSEARCA:GLL) and (NYSEARCA:AGQ) can make it even easier to cover one's downside and protect against falling gold and silver prices or a general deflation, while (NYSE:DOG) will protect you against falling stock prices. ETFs such as (NYSEARCA:TBT) will protect against rising interest rates -- and these are just a few of many, many ETFs to choose from.

There is also TIP S: inflation-proof bonds. Purchase these instead of interest rate bonds if your goal is to protect your money against inflation. You can even dial in the time frame for one year, five years, or even 10 or 20 years.

With smart tools like ETFs and TIP S, it makes no sense to blame the Fed for inflation to the degree that we did 30 years ago. The market has devised a way to protect against inflation! While everyone else is lamenting the "deceptive" nature of government inflation figures, you can select and buy the best ETFs to protect your own personal standard of living, and simply move on. ETFs may not be the perfect investment tool or hedge, but they can be part of an effective strategy to protect you from very real threats of inflation, deflation, booms and busts.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.