(MONEY Magazine) – Retirees in america have never been more prosperous, but one financial goblin still haunts them: inflation. Common wisdom holds that retirees depend on fixed income from bonds and pensions, leaving them almost defenseless against hikes in the cost of living. That explains many seniors groups' testy response to Federal Reserve chairman Alan Greenspan's suggestion in January that the consumer price index, the measure used to figure Social Security's annual cost-of-living increases, ought to be revised downward for technical reasons. "This really works out to be a back-door attempt to reduce cost-of-living adjustments," charges Kimberly Schuld, legislative analyst for the Seniors Coalition.

Our advice: Relax. Retirees are not at inflation's mercy. In fact, in many ways, seniors are better insulated from rising consumer prices than are other age groups. As the graph opposite shows, incomes in households headed by someone age 65 or older rose 6.7% a year over the 19 years through 1993, compared with 6.1% a year for inflation. Over the same period, the average household overall saw a 6.3% annual increase. Naturally, anyone planning to retire must factor inflation into investment planning, but as long as you take some elementary precautions, you needn't worry about being forced to spend your golden years toiling under the golden arches.

But what about those allegedly vulnerable fixed incomes? A myth. "A lot of retirement income is indexed to inflation, like Social Security," points out Michael Hurd, an economics professor at the State University of New York-Stony Brook. Investments also tend to rise with the cost of living. For example, when inflation rises, so do yields on short-term bonds and CDs, allowing holders to reinvest their income and term principal at higher rates. And stocks are excellent long-run inflation hedges. Since 1966, for example, Standard & Poor's 500-stock index has risen at an average of six percentage points a year above the rate of inflation.

Retirees' least inflation-hedged source of income is corporate pensions, but even they may ratchet upward over time. True, only a handful of companies promise to increase benefits automatically with inflation. In practice, however, large companies often voluntarily give pensioners cost-of-living raises as a good-will gesture, particularly when inflation is high. "Private pensions don't go up at the same rate as inflation but they do tend to increase," says Robert Clark, a professor of economics and business at North Carolina State University.

Elders' spending habits also shield them somewhat. Because their homes are often paid off and their children educated, they shell out far less for such fast-rising expenses as housing and college tuition. In fact, retirees spend less than the general population in every category tracked by the U.S. Bureau of Labor Statistics except medical care (see the table on page 132).

To be sure, medical costs have been clipping along at a faster pace than the overall inflation rate. But the growth in health-care costs may be exaggerated by technical shortcomings in the way data is collected for the CPI (which is why Greenspan suggested that the index be revised). For instance, a study by the Congressional Budget Office reports that the CPI often fails to capture health-care innovations such as the use of safer, more efficient drugs, and it doesn't adequately reflect the boom in less expensive generic drugs.

Whatever the true rate of health-care inflation, not all retirees are equally affected by it. Many upper- and middle-income people, for example, are protected by employer-provided retiree health benefits, notes Sheila Zedlewski, an Urban Institute economist. And health expenses typically don't carve too deeply into people's budgets until around age 80; the average octogenarian spends $4,117 annually on medical bills, compared with $2,142 for people 65 to 69, says Marilynn Moon, the institute's senior health policy analyst.

Of course, even if inflation isn't quite the menace you may have thought, you can't ignore it. But financial planners say that you'll have all the protection you need if you keep 30% to 35% of your money in blue-chip stocks or stock mutual funds. Accordingly, we've canvassed mutual fund experts and Wall Street stock analysts for picks in three conservative equity categories that hold special inflation-busting promise right now.

DEFENSIVE GROWTH STOCKS. Now that the economy finally shows signs of slowing (see Money Forecast on page 186), the momentum in the stock market figures to shift to defensive growth companies. These often tend to be consumer-oriented firms that can continue to boost profits even in a lukewarm economy.

One such stalwart is Avon (ticker symbol: avp; recently traded on the New York Stock Exchange at $56; current yield: 3.6%). J.P. Morgan analyst Heather Hay figures that the stock of the $4.6 billion cosmetics company, once as dead as the Avon lady's doorbell, could hit $65 by the end of this year, for a 20% return. A primary reason: Revenues from emerging markets, such as Latin America and Asia, which now make up 33% of the company's total, are expected to grow by 19% a year.

Sears Roebuck & Co. (s; NYSE, $49; 3.2%) has finally discarded its image as a lumbering corporate dinosaur. Thomas Tashjian, an analyst with Montgomery Securities, forecasts that the retailing giant's earnings will increase by 13% to 15% over the next three to four years. In July, Sears plans to spin off its Allstate insurance subsidiary, handing out 95 shares of Allstate for each 100 shares of Sears. Allstate--already 20% publicly owned--currently sells for $27.50. That means that the market is valuing Sears' retailing arm at only $21.50 a share. Dean Witter analyst Patrick McCormack believes that the stock could jump to $60, for a total return of 27%.

Mutual fund investors with a taste for defensive growth stocks should consider Clipper Fund (no load; minimum $5,000; 800-776-5033), which has returned an average of 10.9% annually over the past three years. As of March 1995, the fund held 35% of its portfolio in consumer products and 52% in financial services.

COMPANIES THAT RAISE DIVIDENDS. One way to keep ahead of inflation is to buy stocks of companies that regularly boost their dividend. Such firms tend to have low debt, steady growth and a record of reasonable--if unglamorous--price appreciation to go with their dividends.

One such company is $830 million Safety-Kleen (sk; NYSE, $16.50; 2.2%), the country's largest vehicle- and machinery-parts cleaners, which has raised its dividend an average of 15% a year over the past 10 years. Prudential Securities analyst Vishnu Swarup predicts earnings growth of 15% a year over the next three to five years as the company takes over business from smaller independent cleaners. Swarup also figures that the 36¢ dividend forecast for 1995 could grow to 40¢ next year. He expects the stock to hit $19 a share by the end of the year, for a 17% return.

Several mutual funds specialize in stocks with long histories of boosting dividends. Morningstar's Jeff Kelley recommends Franklin Managed Rising Dividend (4.5% load; $100 minimum; 800-342-5236), up 2.1% annually for the past three years. No-load investors should consider T. Rowe Price Dividend Growth ($2,500 minimum; 800-638-5660), up 12.3% since its inception in December 1992.

EQUITY REAL ESTATE INVESTMENT TRUSTS. Because landlords can raise rents to keep pace with inflation, well-located real estate properties can be terrific inflation hedges. Real estate investment trusts, or REITs, are companies that own and manage a portfolio of properties, in effect letting you become part owner of your own real estate empire without the hassle of collecting rent checks.

Salomon Bros.' Jonathan Litt recommends Equity Residential Properties Trust (eqr; NYSE, $27.50; yield: 7.6%), a Chicago-based REIT with apartments nationwide. "It's having tremendous growth, with rents increasing 6.5%, vs. the 4.2% industry average," he says. The company pays out just 72% of its earnings as dividends, compared with the industry average of 85%, leaving plenty of room for future dividend hikes. Litt expects the stock to hit $32 this year, a 24% total return.

Fund investors can make their move into REITs through real estate specialty funds, which hold dozens of REITs in their portfolios. Two of the best, both no-loads, are Fidelity Real Estate (minimum: $2,500; 800-544-8888), up an average of 8.7% a year for the past three years, and PRA Real Estate (minimum: $2,000; 800-435-1405), up 10.9%.