While inflation has been tame the past two decades, you unfortunately can't invest in the past (otherwise historians would be billionaires). With near-zero interest rates, a growing money supply, and politically unpalatable options to fix the growing national debt (just look at how well the Greek politicians are dealing with their debt), inflation -- a portfolio's silent killer -- is likely to rear its head again. The best way to protect your purchasing power is to own assets whose yields will grow with inflation, such as high-quality blue-chip stocks, REITs, and MLPs. I've already revealed my 3 Disaster-Proof Dividend Stocks and my High-Yield Divided Portfolio to Beat the Market (it is). Read along, and I'll explain why you should be concerned with inflation, how it will affect your portfolio, and I'll pick a stock to protect your assets from inflation.
The silent portfolio killer
While some argue that employed non-investors don't need to worry about inflation, it is a killer for those living off savings and fixed income. Year over year, the producer price index is up 7%, and the consumer price index is up 4%. These are clear indications of rising inflation.
Now some economists will say that core inflation -- which excludes food and energy -- is only 2%, but I have yet to meet a person who doesn't need food or energy. These rising prices eat into returns. For example, investors in 10-year Treasuries, currently yielding 2.125%, are losing purchasing power as they keep their money in them (or breaking even for those investors who don't eat).
Even for equity investors, though, inflation kills returns. As Warren Buffett explained in his 1977 Fortune article, "How Inflation Swindles the Equity Investor":
For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.
And why didn't it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.
Warren then goes on to argue that in aggregate, returns on equity, the "equity coupon," are relatively stable. Rising inflation eats into businesses returns, which leaves less returns for shareholders.
So what options do investors have?
- Gold: When paper money is losing value because the government keeps printing it, people turn to gold because it holds its value. While ETFs like the SPDR Gold Trust (NYSE: GLD ) are an option, resident metals expert Christopher Barker believes Primero Mining (NYSE: PPP ) is the greatest gold stock in the world.
- Real estate investment trusts: Real estate is a classic investment hedge as properties rise in value along with inflation. To be clear, I don't mean mortgage REITs such as American Capital Agency (Nasdaq: AGNC ) , which would be hurt by rising interest rates that would likely go with rising inflation.
- Treasury inflation-predicted securities: These U.S. bonds are like normal Treasury bonds; however, their value is adjusted upward in line with rising inflation. The problem with TIPS is that they are still bonds, and like normal bonds, they will do poorly if interest rates rise, which can happen with or without inflation.
With all that said, there is another way...
Oil products pipelines
Oil pipelines are regulated by the Federal Energy Regulatory Commission and have contracts that adjust for inflation annually. For the next five years, their contracts adjust at the rate of the producer price index for finished goods, +2.65%. The structure of their contracts should allow these companies' payouts to rise faster than the rate of inflation, no matter the rate.
The company I like best in this space is Magellan Midstream Partners (NYSE: MMP ) . To be clear, Magellan is not a stock; it is a master limited partnership. As I've explained before, MLPs can be a great way for investors to earn income and pay less in taxes, but they may require significantly more tax hassles and shouldn't be held in IRAs. For a full explanation, check out this article.
Magellan operates one of the largest pipelines for refined petroleum products such as gasoline and heating oil. Of its contracts, 40% are subject to the indexing method, with the remaining 60% are adjusted at the company's discretion, though these rates track the regulated rates. In July, the company raised "virtually all" of its rates by 7%, consistent with FERC guidelines.
The company currently yields 5%, more than twice the yield of Treasuries. This yield, however, is better than Treasuries since it comes with the built-in inflation adjuster I mentioned above. There's even more to like -- the company has increased its distribution 37 times over the past 10 years at an 11% CAGR. It covers its distribution 1.2 times, meaning Magellan has some money left over to invest in new pipelines.
Foolish bottom line
With a 5% distribution, a very stable business, and built-in inflation protection, Magellan Midstream Partners is definitely worth a look, especially if you are worried about inflation.
Given the tax considerations of publicly traded partnerships, the units may not be for everyone. For those looking for dividends for their retirement accounts, I invite you to take a look at 11 other dividend stocks in a brand new free report from The Motley Fool called "11 Rock-Solid Dividend Stocks." To get instant access to the names of these 11 dividend stocks, click here -- it's free.