The best ways to protect your money
You face 4 big risks in this economy. Here's how to hedge against them - no heavy-duty locks required.
(Money Magazine) -- Everywhere you look, bad news abounds. The falling stock market, the floundering economy, tumbling home values, vanishing jobs - it's enough to make you want to hide your money in a lockbox and throw away the key.
Don't. "The last thing you want to do is panic on short-term economic news," says Houston financial planner Tom Jackson. "That could have dreadful long-term results." Still, it's not imprudent to tweak part of your portfolio to hedge against the four worst risks - let's call them the Four Horsemen of the Subprime Apocalypse.
Such hedges may not come cheap, since everyone wants the same protection these days. But they can buy you the peace of mind you need to keep the bulk of your money in the game.
Inflation Consumer prices are already rising 4% - more than double the rate in early 2004. As the Federal Reserve slashes interest rates to keep the financial system afloat, it could be building the base for more inflation in the future.
Recession They denied it after the real estate bubble burst, but now more than 70% of economists think recession is here. Odds are that it will be mild, but some warn that it could be among the worst in 40 years.
A dollar collapse The greenback has lost nearly half its value against the euro. And with the U.S. economy slowing and rates falling, there's less reason for the world to buy dollars. That could sink the buck further still.
The credit crunch Burned by all those bad loans they made, banks have begun turning away borrowers - even good ones. The risk is that you might need a loan and not be able to get one at a decent rate.
It doesn't take a genius to figure out how inflation threatens your family's finances. All you have to do is open your refrigerator to be reminded that milk costs you 13% more than it did a year ago or fill up your gas tank to see that prices at the pump are 33% higher than they were at the start of last year.
Inflation doesn't have to reach epic proportions to have a debilitating effect on your family's purchasing power - or your investments, for that matter. When inflation surpasses 4% - and keeps on rising - big stocks have generally declined in value, says Sam Stovall, chief investment strategist at Standard & Poor's Equity Research.
With inflation now at that magic number, this is a critical juncture for your portfolio. And if you're a bond investor, inflation is your mortal enemy, since it eats away at the value of your yields.
Think back to the '70s, when government bonds returned 5.5% while inflation was growing 7.4% a year. Treasury Inflation-Protected Securities are supposed to neutralize this problem for bond investors. But inflation worries - and demand for easy-to-sell government bonds - have driven prices so high that TIPS maturing within a few years have effective yields hovering around zero.
At these levels, many buyers are simply paying for the privilege of knowing that if inflation soars they're guaranteed to do better than investors in traditional Treasuries, which don't offer inflation protection. (Bond investors can find better deals today in municipal issues, which carry bargain prices.)
As for stocks, a traditional hedge against inflation has been natural resources. Reason: Fuels, minerals and agricultural goods have a certain amount of usefulness no matter what. You still need wheat to make bread, and your grocer will sell you a loaf if you slap down a gold coin.
But since commodities don't throw off interest or dividends, their price on any given day is just a guesstimate of future supply and demand. And because they've shot up tremendously in short order (gold went from $800 an ounce in December to past $1,000 at one point in March), they carry substantial risks of their own.
The stocks of companies that mine, farm and drill for these commodities haven't rocketed as quickly. That's one reason you're better off in a fund like T. Rowe Price New Era (PRNEX). This Money 70 stalwart invests in oil and natural-resources companies such as ExxonMobil (XOM, Fortune 500) and Schlumberger (SLB) - not in the commodities themselves.
The fund has risks, of course. It has gained nearly 30% a year for five years; if oil prices fall and inflation subsides, you could lose money buying in at this level. So understand what you're getting with New Era: not a chance to win big but insurance against the risk that inflation will get worse.
If peace of mind is worth it to you, shift about 5% of your stock portfolio from other large-caps to the fund. That's enough for insurance but not so much that you're betting your future on commodity stocks.