How to build a portfolio wisely and safely
September 15, 2009 · Tagged with Retirement
Deflation
Portfolio preparation is easier for deflationists: Put a chunk of money into long-term Treasury bonds and much of the rest into cash and some municipal bonds.
If broad-based deflation materializes, long-term Treasurys are likely to surge. The bonds’ fixed-income stream, meanwhile, would be worth increasingly more relative to falling consumer prices.
Some investment-grade municipal bonds could serve a similar role while also providing tax advantages for high-income earners. But beware: Deflation would likely mean some taxing authorities struggle to service bonds reliant on a specific income stream, like user fees. Instead, stick to “investment-grade bonds tied to necessary services like water and sewage, power or necessary government offices like, say, a courthouse building,” says Marilyn Cohen, president of bond-investment firm Envision Capital.
Round out your deflation portfolio with a big slug of cash. Though it won’t generate much of a return in a low-rate, deflationary environment, cash in the bank will gain value as prices fall.
Insurance Component: Commodities react most drastically to surprise inflation, so they should be part of your insurance. Add in TIPS, too, and stocks geared “toward consumer-staple companies,” says Ibbotson’s Mr. Gambera. If inflation arises, companies such Coca-Cola, tobacco giant Altria, and toothpaste maker Colgate-Palmolive will have some pricing power.
Goldilocks Economy
Maybe, just maybe, world bankers will get this right, and the economy will experience neither severe inflation nor severe deflation.
“We think most likely the central banks of the world will get this close enough to right that we will settle in close” to a relatively benign inflation rate of between 1.5% and 2.5%, says Aaron Gurwitz, head of global investment strategy at Barclays Wealth.
In such a “Goldilocks” scenario — where the economy is neither too hot nor too cold — “risky assets would do best, so equities and bonds with some equity characteristics should receive the emphasis,” says Scott Wolle, portfolio manager of the AIM Balanced-Risk Allocation Fund.
That means broad exposure to large-cap and small-cap U.S. stocks through funds such as the Vanguard 500 Index Fund or the Bridgeway Small-Cap Value fund; and exposure to developed and emerging markets through funds like the Vanguard Total International Stock Index Fund (mainly developed markets), and the T. Rowe Price Emerging Markets Stock Fund.
For the bond component, pick a fund such as the Fidelity Total Bond fund that largely owns high-grade, intermediate-term corporate bonds and mortgages, along with government and agency debt.
Insurance Component: Just in case the Goldilocks scenario is wrong, you will need insurance against either inflation or deflation. Pick up inflation protection through a commodity ETF, and deflation protection with long-term Treasurys. Cash also is OK in either situation.