Inflation is one of the chief enemies of all consumers and investors. This invisible force inexorably erodes both your purchasing power and the returns you receive on your investments as the prices of goods and services rise. Of course, this effect is not all bad, as it is an inevitable result of economic growth. But it is important for you to know how to protect your savings from shrinking in value over time as a result of this factor. Fortunately, there are several types of mutual funds that can protect you from inflation in different ways.
1. Ditch Your Dollars, Invest Abroad
International mutual funds provide growth and diversification for your money. As with domestic stocks, international companies have historically grown faster than the rate of inflation over time. Global mutual funds provide even more diversification because they can invest both here and overseas. These funds also provide a measure of diversification that cannot be found otherwise, as the markets in other parts of the world are often booming when the U.S. markets are slumping.
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2. Find Funds that Pay Dividends
Dividends can substantially increase the total return realized by stockholders over time, and usually combine with capital gains to outpace inflation. Mutual funds that invest in dividend-paying stocks have a solid track record of growth. These funds are good buys for investors who would like to receive a stream of income from their portfolios.
3. Consider Commodities
Although commodities haven’t always outperformed inflation over longer periods, they can leave it far behind in shorter time spans. Gold and oil have risen exponentially in the past 10 or 15 years and show no sign of returning to their previous levels. The increase in the price of food and other goods has also outpaced the general rate of inflation in recent years. Funds that invest in these instruments may be a better pick for shorter time horizons.
4. Go for High Yield
Even though they are linked to inflation, there are fixed-income instruments that yield more than inflation over the long term. Junk and corporate bonds, preferred stocks, senior secured loans and callable CDs all typically pay rates of interest that exceed the inflation rate. And when interest rates go down, the prices of the securities held by the fund will rise, thus providing you with some capital gains on top of interest and dividends.
5. Go Small
Small-cap stocks have historically grown faster than just about any other asset class or sector, albeit with a great deal of volatility at times. Mutual funds that hold small cap stocks also tend to vacillate with the markets more than other types of funds, but the returns that they post over time have left inflation far behind.
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6. Go Big
If small cap stocks contain more excitement than you are looking for, large cap stocks can still get you ahead of inflation over time with much less volatility. Of course, their historical returns have lagged their small cap cousins, but it would take something very drastic for a large-cap mutual fund to crash and never recover. There has only been one negative rolling return in the Standard and Poor’s 500 Index in all of history.
7. Energize Your Portfolio
The world’s demand for energy is growing at an ever-increasing rate, and mutual funds that invest in energy companies have seen healthy returns over the past few decades. New discoveries and technology in the drilling and extraction processes for both oil and gas have made this sector more viable than ever. This trend shows no sign of slowing, and investors who buy these funds are purchasing a solid long-term hedge against inflation.
8. Utilize Your Funds
Markets may rise and fall, but the public need for water, gas, electricity, sewage and trash removal remain constant. Utility stocks usually offer much higher yields than banks, credit unions or treasury securities or savings bonds, albeit with a bit more volatility. Mutual funds that invest in utility stocks tend to rise and fall in price in a cyclical fashion along with the economy, but the dividends that they pay usually keep them firmly ahead of inflation on the growth curve.
9. Keep Your Portfolio Healthy
The price of healthcare has risen much faster than the rate of inflation for the past several decades, and this trend is likely to only intensify for the foreseeable future. The cost of managed care is in danger of spiraling out of control and many of the companies that provide these services along with pharmaceutical conglomerates and other major players in the healthcare field have experienced long-term double-digit growth. This is unlikely to change any time soon, as new drugs and treatments become available for the diseases and other ailments that plague us.
10. Index Your Portfolio
History is showing more and more clearly that while the markets themselves have grown faster than the rate of inflation over time, most mutual fund portfolio managers have been unable to keep up with, let alone outperform the markets over the decades. The obvious solution here is to simply buy index funds that are not actively traded , such as the Standard & Poor’s 500, the Russell 2000 and 3000 Indices and the Wilshire 5000. Your money can then grow faster than inflation with a minimum of fees and expenses.
The Bottom Line
Although mutual funds that invest in the areas listed above cannot guarantee the return of your principal, the better performers have been able to stay ahead of inflation over the long term. All in all, taking the time to consider some of the various types of investments profiled above may help you escape the negative consequences of inflation over time.