How to Invest During Deflation

Economic deflations present special challenges for investors.

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Falling prices and decreasing asset values are symptoms of economic deflation. As the economy slows, demand for goods and services drops and employees are laid off as production slows. Higher unemployment means fewer people with money to spend, which kicks off a new round of layoffs and production slowing. During deflationary times, investors should focus on capital preservation instead of looking for high yield.

Step 1

Keep your cash. Every downward tick of the Dow increases your money’s purchasing power. If you are interested in metals, gold historically offers investors a safe haven during deflationary times. Silver and copper prices, however, fall as industrial use and new housing construction demands decline.

Step 2

Confine your stock market investing to deflation-proof sectors including utilities, health care and agricultural goods. Utility stocks have a captive consumer base and don’t need to lower their prices to attract new users. Select utilities with a strong balance sheet, gains that exceed the Dow Jones Industrial Average, a history of regular dividend payments and increased earnings and operating margin growth. Use your stock screener to select the best stocks for each sector.

Step 3

Consider investing in inverse exchange-traded funds that are designed to profit from the deflating economy. You can select from ETFs that inversely mirror the Dow Jones Industrial Average, S&P 500, Russell 2000 and QQQ. For example, if the S&P 500 Index drops 1 percent, the ProShares UltraShort S&P 500 will rise 2 percent. ProShares ETFs are highly leveraged at 200 percent, making them a more risky investment.

Step 4

Limit your risk while increasing your bank account balance by investing in bonds. U.S. government bonds offer fixed interest rates in varying denominations. You can also invest in short term tax-exempt bond funds to lock in a higher yield while lowering your taxable income. As an alternative, mutual funds have foreign bond funds that will help diversify your portfolio and offer better yields. You can use your bond screener to find no-load bond funds with low management fees that carry a good interest rate.

Step 5

Consider which deflation-friendly investments fit your trading philosophy. Use your online account to open a trade for stocks and ETFs. Go to the bond fund’s home page and open an account online. Wait until your account is open to place your trade for domestic or foreign bond funds. You can purchase U.S. bonds online from the Treasury Direct website.