It's an ugly statistic: The current yield on a 10-year US treasury bond is 3.8% -- before tax, of course. At the same time, the consumer price index, which tracks the price of a basket of common goods, went up by 4.3% in the past year, and it shows no signs of slowing down.
For U.S. treasuries -- one of the world's most beloved investments -- inflation has rendered real returns no more appealing than a firm slap in the face.
As Warren Buffett once remarked, "I've worried about inflation every day since I learned about the phenomenon 60 years ago." While I wouldn't lose too much sleep over it, inflation certainly has measurable effects on your investments. Still, don't assume you have no control over it -- because you do.
Not now, I'm busy making ends meet
Inflation is of particular concern right now, because we're heading toward an economic slowdown (if we haven't gotten there already). Jobs and income tend to grow scarcer during such times, and when prices go up and income goes down, the economy effectively adds insult to injury.
Factor in a Federal Reserve that remains bent on slashing interest rates like there's no tomorrow, and we've got ourselves one heck of an inflation beast to deal with. What to do?
If you've got a good portion of your nest egg in stocks, there's good news: Stocks naturally provide a bit of an inflation hedge. For some companies, price increases can lead to an equal increase in earnings, so in the end, shareholders don't feel the full wrath of inflation. Some stocks provide much better inflation hedges than others, though. Here's what to look for.
Inflate your returns
When a company can raise prices to keep pace with inflation, or surpass it, you've got some serious inflation protection on your hands. Just last week, food giant Sara Lee (NYSE: SLE) hinted that it would tackle the monumental rise in commodity prices by passing the costs on to consumers. People need to eat, regardless of price, and personally, it'd take one hefty hike to get me to give up my Jimmy Dean sausage in the morning. Problem solved.
Other inflation slayers could include Procter & Gamble (NYSE: PG), Altria Group (NYSE: MO), Starbucks (Nasdaq: SBUX), and Johnson & Johnson (NYSE: JNJ). These companies can all name just about any price they wish, and consumers will happily oblige, either because they must have the products today, or they're just downright addicted to them.
But Ford (NYSE: F) can't say the same. Car buyers are so price-sensitive that the automaker has absolutely no room to shift increasing costs onto consumers. If prices go up, people simply won't buy cars until their old ones resemble Flintstone-mobiles. Arcelor Mittal (NYSE: MT) , the world's largest steel producer, announced plans last week to raise prices by as much as 15%. What can companies like Ford do about that? Nada. Suddenly the tides are turned, and these companies, rather than their customers, become prisoners of pricing. Investors should avoid stocks like these whenever possible.
One more TIP
If you're closer to retirement, or if stocks just aren't your thing, don't lose hope! Many bond instruments have built-in inflation hedges that can handily pay off during times like these. TIPS, or Treasury Inflation Protected Securities, are bonds with an added bonus payment upon the bond's maturity to match any damage caused by inflation during the life of the bond. There are ETFs that make it all too easy to get in on the action, such as iShares Lehman TIPS ETF, as well as a handful of mutual funds that provide similar services.
If you're shaking in your boots about the Fed cutting rates, oil bouncing against $100, and those commercials claiming the price of gold will be halfway to Jupiter in the next few years, take heart. Keep an eye on how inflation pressures might affect your investments down the road, and you'll end up owning inflation, rather than it owning you.
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