Protect your Investments in both Inflation and Deflation.

With fears looming that the federal government will begin to withdraw stimulus this year, coupled with high unemployment rates and slowly growing wages, some economist believe significant deflation is in America’s future.   On the other hand, many economists believe that the economy will face the opposite problem – high inflation due to extensive government borrowing in the aftermath of the financial crisis.  Forecasters are predicting an initial drop in prices, followed by a sharp and expensive increase in prices.  If the economy’s roller coaster-like ride projects a future laden with both inflation and deflation, both of which beg a different way of investing your money, how do you protect your assets against both?  The key to securing your investments against both inflation and deflations starts with shifting a small chunk of your portfolio towards assets that can protect you in the event of either crisis.  Below are a few investments that can help you do just that.

Purchase stocks with pricing power.  With both deflation and inflation threatening the consumer economy, it is key to shift your portfolio towards firms that produce and sell products or services that consumers must buy no matter what.  Defensive industries such as health care, consumer staples and agriculture not only hold up well during an economic crisis, but also maintain their earnings growth throughout most economic conditions.

In the case of deflation, you want to own shares of large companies with a lot of cash on their balance sheet, with little to no debt.  Firms that borrow heavily experience difficulties securing or refinancing loans in troubled times.  However, cash-rich shares may be a decent hedge against inflation due to their higher trade valuation, and the fact that they pay regular dividends, regardless of the economic situation.  Furthermore, in inflationary times, the market typically favors cheap stocks.

Emerging-market stocks may be pricy and risky, but are a great inflation hedge because their prices tend to keep pace with inflation.  They can also provide diversification in the event of deflation too.  Just be careful how much you actually invest in these stocks; consider keeping about a quarter of your foreign equity portfolio in these shares.  Similarly, investing in foreign bonds can not only produce higher yields, but can also protect against both inflation and deflation when the U.S. dollar isn’t performing at its finest.

Inflation-indexed bonds, such as treasury inflation-protected securities, adjust their principal value to keep up with inflation.  If deflation occurs, the principal value of the bond is adjusted downward when calculating your interest.  If you hold the bond to maturity you’ll receive your full principal in return.

Finally, commodities and real estate can offer solid protection against inflation over short periods.  Thats because when inflation is surging, natural resources like oil, food, and raw materials soar in price too.   However, during times of deflation, real assets tend to lose their value.  The key here is to invest a small portion of your portfolio in real assets to boost diversification, because they typically tend to be unassociated with equities.  Taking a small stake in real estate and commodities can lower your overall risk regardless of the economy.

The best part about these investments is that regardless of whether the economy is hit with a one-two punch of deflation and inflation, these tactical moves will help you better diversify your core holdings of stocks and bonds.  Don’t let the economy’s unpredictable future scare you – simply take the right precautionary steps to secure your investment and financial future.