Portfolio Insurance For Cheap

By Aaron Levitt | August 29, 2009 AAA

With the economy in a coma, the U.S. government and Federal Reserve gave the prescribed a hefty dose of medicine: stimulus plans, tax rebates and various other programs all with the intention of jump-starting the economy's heart. While these programs seem to be working and the economy is slowly regaining some of its former steam, no good deed goes unpunished. In this case, this flood cash has the potential to create the ultimate wealth destroyer - inflation.
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The Growing Problem
Inflation isn't a guarantee. However, the possibility is gaining momentum. This uncertainty towards an inflationary environment stems from the notion of rising commodity prices and a falling dollar. Prices of raw materials have been on a tear in 2009. The broad-based commodity index ETF, the iShares S&P GSCI Commodity-Indexed Trust (NYSE:GSG) is up nearly 9% year to date, after its 46% drop in 2008. Much of this growth is coming from emerging markets, such as China, which are continuing to buy natural resources at an unprecedented speed to build out their nations. Analysts believe that once the world's economy returns to a state of normalcy, buying will intensify globally, pushing commodity prices even higher. With last summer's $150 a barrel for oil still fresh in our minds, we can see how this is major concern.

The second piece to the puzzle is in that of a falling U.S. dollar. A declining greenback first causes imports to be more expensive, adding to an inflationary environment and rising prices. Secondly, oil, gold, cotton and everything else under the commodity umbrella is priced in U.S. dollars, worldwide. A falling dollar ultimately leads to higher prices.

Purchasing Insurance
Long-term inflation is a given. In the short term, the question is severity. Luckily, there are a few ways for investors to protect their portfolios from its cold hand. In 1997, the U.S. created Treasury Inflation Protected Securities (TIPS). These bonds, backed by the full faith and credit of the federal government, provide a fixed coupon plus a rate that is adjusted based on changes in the Consumer Price Index. This prevents erosion of purchasing power. The easiest way to add TIPS bonds to your portfolio is through exchange traded funds. There are two ETFs that provide exposure, the biggest being the iShares Barclays TIPS Bond (NYSE:TIP), with nearly $15 billion in assets, followed by the SPDR Barclays Capital TIPS (NYSE:IPE) with $301 million. Both funds provide some benefits over individual TIPS, including the payment of monthly dividends over the bonds semi-annual payments. The funds charge 0.2% and 0.18% in expenses, respectively, and each yield around 2%.

Other nations have followed suit with the success of the TIPS product. The SPDR DB Intl Government Inflation-Protected Bond (NYSE:WIP) gives investors a chance to diversify their inflation investments outside the United States. Top holdings include inflation bonds from France, Poland, Mexico and Japan.

Profiting From the Falling Dollar
Adding protection for a continuing falling dollar is another inflation insurance device. The PowerShares DB U.S. Dollar Index Bearish ETF (NYSE:UDN) is designed to duplicate the performance of being short the U.S. dollar against a basket of foreign currencies. These include the, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, Swiss Franc and a nearly 57% weighting in the Euro. The fund allows investors to make a direct and decisive bet that the greenback will go down. The fund is up around 2% year-to-date, and charges 0.55% in expenses.

The Bottom Line
With the world's economies beginning to show signs of growth, the risks of inflation are being pushed to the forefront once again. Insurance against higher prices is selling cheap. Now may be the time to purchase some protection, both for the short term and long term. These ETFs, including the iShares S&P GSCI Commodity-Indexed Trust (NYSE:GSG), offer an easy and cheap way to protect purchasing power. (To learn more, check out our Inflation Tutorial.)

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