How Do You Preserve Purchasing Power in a Tumultuous Economy?
Elliot Raphaelson

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The recent dramatic fall in equity prices around the world has made all investors nervous. They want to know how to preserve their capital and maintain purchasing power. Should they completely "bail out" of equities, and take their losses now, or risk further drops because of market uncertainty and the downgrading of U.S. debt? No one knows with certainty.

Bill Gross, co-CEO of Pimco, the large investment management firm, who is considered one of the best market analysts, recently analyzed the impact of the recent budget deal. He feels that the budget agreement won't solve our deficit problems, and that inflation will continue. He also indicated that the continued high deficits and low interest rates maintained by the Fed will continue to result in a declining dollar relative to strong currencies. If he's right, this will result in a tax on our standard of living.

Gross believes that in order to preserve purchasing power, you should favor investments in countries with higher "real interest rates" -- i.e., the interest rate minus the inflation rate -- such as Canada, Mexico, Brazil and Germany. He also recommends shifting equity and fixed-income investments away from dollar-based indexes toward developing nations with stronger growth prospects. He also believes that a portion of your portfolio should be in commodity-based real assets.

What should you be investing in?

One investment to consider for a small part of your portfolio is Treasury Inflation-Protected Securities (TIPS), in which the principle is adjusted to the Consumer Price Index. (Pimco uses TIPS in many of their portfolios.) These are issued for terms of 5, 10 and 20 years. However, if you purchase them through a mutual fund, you do not have to be concerned about maturities. This investment will protect both your principal and interest from inflation. In periods of anticipated inflation, this investment does well. During the dramatic fall for most securities the last few weeks, TIPS have maintained their value, and have returned about 10 percent this year. I have invested in Vanguard TIPS (VIPSX) for several years and the performance has been very good. The average return for the last 10 years has been 6.7 percent, and the performance has been consistent. On a long-term basis, you should obtain reasonable returns and have inflation protection. I recommend that you keep this investment in your tax-advantaged retirement accounts such as an IRA or 401(k). Otherwise, the increase in value is taxable even if you do not sell your shares.

Another investment to consider is investment in gold. Gold prices also generally do not move in the same direction as common stocks and bonds. In low interest environments, and when the U.S. dollar does poorly in comparison to other currencies, gold prices generally increase. You should be aware that gold prices can be volatile. Before investing in gold, I recommend thoroughly educating yourself. An excellent book I recommend is "All About Investing in Gold," by John Jagerson and S.Wade Hansen (McGraw Hill, 2011). The book is very comprehensive and covers all the major forms of gold investment.

If you decide to invest in gold, one of the investments the authors recommend is gold bullion exchange traded funds (ETFs), because of their convenience, liquidity and efficiency. They feel ETFs are the lowest-cost way to gain access to professional management. They felt that SPDR Gold Trust ETF (GLD) is a good choice, because of its size, low cost and liquidity. Because of market volatility, you should dollar-cost average -- that is, make regularly scheduled purchases in the same dollar amount over time.

Some market experts, such as Steve Forbes, believe you should be purchasing common stocks and funds now. I suggest that when and if you decide to purchase common stocks or funds, use dollar-cost averaging. It is impossible to accurately predict market tops and bottoms.

I don't pretend to know how to predict market tops and bottoms. I do recommend, however, a diversified portfolio, with a reasonable percentage of short and intermediate-term high quality bonds or bond funds. In addition, because of the volatility in the markets, it is important not only to have a diversified portfolio but also to have some investments that do not move in the same direction of most other investments.

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