Inflation investing

By Linda Stern

WASHINGTON (Reuters) - Gas, gold, food, fuel: Up, up, up, and up. Inflation is already showing up in key commodities, and many economists think more is on the way.

With the Federal Reserve pumping dollars into the banking system, and the Federal government pushing stimulus checks at consumers, it has already been baked into the cake.

That's no surprise to the financial markets, which have bid up commodities and inflation-protected bonds and pushed down the value of dollars. Small investors are late to the game: If you haven't already tucked away some inflation-fighters in your portfolio, you'll pay dearly for them.

But it's got to be done. Rising prices can rip through traditional stock-and-bond portfolios faster than you can say: "How much is that gallon of gas?" That doesn't mean you should run out and buy gold coins to stash under your bed. Five years ago, gold was selling for $320 an ounce; this year it topped $1,000. And it costs money to buy, store and protect actual gold.

Here are some more practical ways to make sure your portfolio is protected from inflation.

-- Buy blue chip stocks. "Stock investors are likely to fare better in an inflationary environment than bondholders," writes Morningstar analyst Chris Davis. In particular, solid companies that sell things consumers always need, like drugs and food, often have room to raise their prices and pass through rising costs. Companies that have enough cash flow, and don't need to borrow money in an inflationary environment, can provide some safety.

-- Beware of bonds. Interest rates eventually have to go up if the value of the dollar stays weak, because it will take higher interest rates to attract lenders. And rising rates are death to folks who own long-term bonds. If interest rates go up a mere 1 percentage point, that would cut the value of a 10-year Treasury bond by 7.13 percent. Bond mutual fund returns would fall if rates started to rise. Long-term rates now remain comparatively low. It makes sense right now to keep much of the bond side of your portfolio in shorter term investments.

-- Buy traditional inflation-fighters sparingly and carefully. It does make sense to keep 5 percent to 10 percent of your portfolio in anti-inflation investments like commodities, natural resources companies and real estate. But this remains an expensive time to buy the former and a scary time to buy the latter. If you don't have any of these investments yet, move some money into them very gradually, suggests Davis. Use dollar-cost-averaging techniques of buying a little bit every month to protect you from buying in at the wrong time.

-- Consider TIPS. Treasury inflation-protected securities have built-in guarantees that their yields will keep pace with inflation. But those yields are currently very low: a 10-year TIP promises to pay only about 1.3 percent over the inflation rate now. Safety-minded investors might want to tuck some shares of a TIP-buying fund into their retirement accounts, but don't expect any big cashing in. A couple to consider are Vanguard Inflation-Protected Securities Fund (VIPSX) and Fidelity Inflation-Protected Bond Fund (FINPX). Better returns and the same inflation guarantees can be found through corporate inflation-protected bonds, some are sold at http://www.incapital.com.

-- Go abroad. Brazilian and Canadian natural resources companies will do well if the prices of their metals, paper, wood and other products continue to rise. Foreign inflation-protected bonds have been offering bigger returns than U.S. TIPs. You can get them through a new exchange-traded fund, SPDR DB International Government Inflation-Protected Bond ETF (WIP).

(Linda Stern is a freelance writer. Any opinions in the column are solely those of Ms. Stern. You can e-mail her at lindastern@aol.com.)