The argument over inflation has reached fever pitch as investors turn to gold, TIPS and index funds to diversify their portfolios and beat the specter of declining purchasing power. However, if inflation fears are not realized, these three investments still serve as good ways to diversify your portfolio in a difficult economic climate.Gold has historically been one of the investments of choice for people seeking to hedge against the loss of the purchasing power of paper currency. Shares of iShares COMEX Gold Trust ( IAU) and SPDR Gold Shares ( GLD) represent a direct investment in the price of physical gold bullion, stored in protected locations. These funds do not invest in equity securities or complicated derivatives -- just the real deal. An investment in IAU or GLD also allows investors to take a stake in physical gold without state of the art security and a giant vault.
The Federal Reserve has sustained an unprecedented effort to increase the money supply while keeping short-term rates next to zero, and some funds like TIP have skipped dividend payments to investors because of low rates. TIP is a good way to protect a small portion of your portfolio against the risk of rising rates in the future. TIP should be an investment for the long haul, however, and investors looking to capture the upside will have to endure the current doldrums stalling the fund. TIP owns solely inflation-protected securities backed by the U.S. government, which also may provide some comfort to investors looking to minimize credit risk in at least a portion of their portfolios. TIP is a good low cost way to add inflation protected securities to the mix.
Index ETFs such as iShares Russell Midcap Index ( IWR), S&P Depository Receipts ( SPY), PowerShares QQQ ( QQQQ) and the DIAMONDS Trust ( DIA) offer investors a low-cost vehicle to diversify their portfolios and stem the effect of inflation. IWR is a low cost mid-cap fund that invests in a large number of securities to provide investors with diversification. SPY is a plain vanilla approach to large-cap investing, and this fund has had a high correlation to broader market movement. SPY is also one of the cheapest ETFs available. Investing in ETF index funds helps to cut costs and take some of the guesswork out of diversified investing. While U.S. equity index funds are not "inflation proof," many have outperformed over time and provided more stable returns for conservative investors.
While investors have already begun guarding their portfolios against inflation, current data has yet to exhibit clear signs of this particular economic worry. The market for inflation-protection investments has run up hard and fast despite little hard data. Fears caused by inflation or even deflation, however, remind us of why it is increasingly important to have a well diversified portfolio. Chasing inflation fears or any trend is likely to result in losses. A well-diversified, long-term investing approach is the best way to battle economic uncertainty. While actual inflation is low, it may be the best time to invest a small portion of your portfolio to guard against it for the next few years.