Many of us investors have different needs that can arise such as: capital growth, retirement at a certain age and with a certain lifestyle, paying off a mortgage before it is due, changing a car, paying for children’s tuition or donation to relatives or charity. . In some of the countries, salaries are indexed with a percentage close to the inflation rate. For example, Luxembourg, the country I live in now, is one of them.
Why is it important to take inflation into account? Let me give you an idea and let’s assume you are a bond investor. Barclays current aggregate, which is a benchmark for bonds, points south for the US with a YTD yield of -3.34% and a modest 0.15% gain for EU investors . Now, if you add the latest annual inflation published by the US government of 2% in July 2013 and the 1.6% HCIP for Europe, you would have a negative return. Some of you may argue that you do not mark your bonds to market and would hold them to maturity. Fair enough, but does the coupon you receive cover current inflation or, especially, future inflation? Let’s not fool ourselves with the current environment, modest inflation and low interest rates. The billions that governments print will have the effect expected by many of us: sooner or later they will produce inflation. And the high rates of inflation will be addressed with the increase in the interest rate and so on.
So what can we do to protect our portfolios from inflation? Many investors still remember the extremely high volatility in the stock market that occurred after the Lehman bankruptcy and many of them have stayed on the sidelines ever since. Let’s not forget the risk-averse investors who hate a loss more than a gain of equal amounts. These two patterns of investor psychology and behavior caused many investors to miss the rally in stocks that started in March 2009 until today. This brings me to the topic:
The two assets that I like are: stocks and real assets.
But first let’s talk about gold because most of us learned in school that commodities tend to behave in the same direction as inflation. Some investors believed that gold would protect their portfolio yields from being eaten up by inflation, but the latest volatility in the price of gold has shown that it can no longer be trusted as a safe asset (nor can government debt). . And of course, if the price drops below $1,200 an ounce, a lot of the companies out there will have to shut down and put a lock on the door, but that’s another story. The bottom line is: don’t use gold as an inflation hedge because it doesn’t pay dividends, it doesn’t have an IRR, and its price can’t go up forever! Other products are also not favored. Simply put, playing with merchandise should ONLY be handled and performed by professionals. I will talk about commodities in another post.
Instead of gold, what I really like is real assets. Whether we are talking about commercial/retail real estate, farmland, etc. It provides a steady stream of income just like coupons for bonds and most of the time outperforms the coupon yield, but most of all it can increase in value when inflation spikes.
With stocks the math is simple, I always suggest that an individual investor without an advisor or portfolio manager looking after their portfolio should invest in no more than 5-10 stocks that they can keep track of. Yes, he should be able to do proper due diligence and homework him on 5-10 stocks, add them to his portfolio and keep a close eye on them. Now, the stocks he chooses must be in accordance with his goals: growth stocks, value stocks, speculative stocks.