Inflation is a pervasive and persistent rise in prices related to an increase in the volume of money and resulting in a loss of the value of currency. One way of fighting inflation's effect on your investment portfolio is to buy mutual funds that invest in commodities. Another tactic is buying mutual funds that invest in real property, or in real estate investment trusts, called REITS. A third approach is to buy mutual funds that invest in Treasury inflation-protected securities.
Commodities are anything that comes out of the earth, such as oil, gold and wheat. As investments, they are grouped with other products, such as energy, that are fungible. For example, there are a few different grades of crude oil, but within each grade, oil that comes out of one well is as good as oil that comes out of another. This distinguishes commodities from goods. A Volkswagen generally costs less than a BMW because of perceived differences in value. Because commodities don't have qualities that make one instance more valuable than another, they are easily traded.
Investing in Commodities
As inflation reduces the value of money, it takes more money to buy an item like oil, with a value that remains fixed, subject only to changes in supply and demand. Therefore, over the long run, commodities tend to rise in price with inflation, but they do not rise in lockstep. Events affect supply and demand, and, therefore, the short-term value. A hurricane in Florida increases the price of orange juice futures. A Middle East peace agreement reduces the cost of oil. A broad-based commodity fund may provide a hedge against inflation, along with diversification that may protect you from the sharp price swings of individual commodities.
Because, historically, real estate prices rise with inflation, real estate mutual funds may provide protection against inflation. The problem with investing in it directly is the cost of property -- only the wealthiest investors can assemble a diversified property portfolio. Mutual funds that buy stocks of companies holding and developing real property provide one way for an individual investor to participate in real estate. Another is buying mutual funds that invest in REITs. The T. Rowe Price Real Estate Fund, for example, invests largely in trusts that invest and manage income properties, such as shopping malls, hotels and large-scale rental properties. Its annual return on investment for the five years following the end of the recession in June 2009 was a little under 7.5 percent.
TIPS is the acronym for Treasury Inflation Protected Securities, another form of inflation-fighting investment. These are specialized government bonds with principal amounts that rise in proportion to inflation. Funds that hold TIPS, such as iShares Barclays TIPS Bond Fund, buy TIPS treasury bonds with a variety of maturity dates. Mutual funds holding a portfolio of TIPS with relatively short maturities will be less volatile and will generally have a lower return than a portfolio of TIPS with longer maturities.
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