After a long and strong bull market that has some talking about bubbles, retreating to the apparent safety of less risky investments may seem like a smart move. But in today's market environment, you're running out of options to both play things safe and preserve the purchasing power of your hard-earned money.
Locking in losses is not something most people can afford. Later in this article, I'll point you toward some investing ideas that can help you fight the risks that plague your portfolio, rather than simply accepting losses as inevitable.
Is inflation back?
A report from Bloomberg yesterday pointed out an uncomfortable truth for conservative investors sticking to fixed-income markets: Many so-called "safe" investments are actually guaranteeing investors that they'll lose some of the purchasing power of their savings to inflation. With the average five-year CD rate at 1.7%, savers aren't earning enough to make up for the impact of inflation, which has run at more than 3% during the past year. Even by going to top-paying banks like the banking divisions of Discover Financial (NYSE: DFS) and AIG (NYSE: AIG), which are willing to pay higher rates in order to attract much-wanted capital from customers, you still can't come close to matching inflation, let alone beating it.
CDs aren't the only low-risk investment that isn't cutting the mustard lately. As Bill Gross tweeted earlier this week, five-year Treasuries yielding in the 1.7% to 1.8% range won't stand up to inflation and provide positive real returns. And it couldn't be clearer than with the Treasury's inflation-indexed TIPS, where five-year maturities carry a current negative real interest rate of -0.34% -- guaranteeing a loss in inflation-adjusted terms.
Two strategies to deal with inflation
Unfortunately, the recent uptick in inflation doesn't look like it will be disappearing anytime soon. Even as commodities have come crashing down over the past month, some key components in personal budgets have remained stubbornly high. Despite concerns about potential demand destruction, oil prices are hovering around the $100 level.
And even with the sharp correction in the high-flying silver market, prices are only back in line with their longer-term uptrend. That puts wind in the sails of shareholders in both bullion ETFs such as Sprott Physical Silver (NYSE: PSLV) and silver-related companies such as Silver Wheaton (NYSE: SLW), which believe that precious metals are the only pure inflation hedge against inevitable monetary devaluation.
But others believe that precious metals could collapse a lot further from here. That's why a combination of two strategies might leave you in the best position to avoid inflation.
1. Hold cash.
If five-year CDs paying 2% can't beat inflation, then short-term savings accounts paying 1% certainly can't. But the rationale behind holding cash isn't about current yield but rather about having dry powder ready to capitalize on future opportunities. Especially if you believe that the stock market has come too far too fast lately, ramping up cash levels with your eyes on making smarter purchases in the near future makes plenty of sense.
2. Get cheap stocks with good dividends.
The other strategy is one that many Fools are following right now: picking dividend-paying stocks that are stable enough to hold up well even if the stock market turns south.
Some examples of such companies include Procter & Gamble (NYSE: PG) and PepsiCo (NYSE: PEP). Both of those companies have recently shrunk package sizes in response to higher input costs. Those moves will help preserve margins and demonstrate the pricing power that top-branded blue-chips have over less popular competitors.
Yet you can find high dividends even in areas you might not expect. Intel (Nasdaq: INTC), for instance, has an above-3% yield despite the overall trend of tech stocks paying little or nothing in dividends. It's also among the many big-name tech companies with cheap valuations below that of the overall market.
Be a winner
Investing isn't about sure things. You have to take some risk to earn decent returns. But rather than locking in a guaranteed loss, you'll do much better finding alternatives that give you a fighting chance to make real money in the long run.
Learn the basics of financial planning in our 13 Steps to Investing Foolishly. It'll get you on track to a great financial plan in no time.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.
