Money Watch: Will gold protect investment against inflation?
— -- Money Watch, a personal finance column that runs every Saturday, features a financial planner from the National Association of Personal Financial Advisorsanswering reader questions about saving, protecting and growing your money. To submit a question, e-mail USA TODAY personal finance reporter Christine Dugas at: cdugas@usatoday.com.
Q: If gold is not a wise investment, where can little guys like me put my hard-earned money as a hedge against inflation? The government may say that the inflation rate is running at about 2% to 3%, but that doesn't reflect the rising cost of food and gas.
A: Unlike stocks and bonds, gold generates no income (dividends or interest). Investors gain only if they are able to sell for more than they paid. Since gold prices are subject to the vagaries of supply and demand, purchasing gold is more speculation than investment.
Protecting your investments from the corrosive effects of inflation is a smart move. Be aware, however, that future inflation is unpredictable, and no single asset class offers effective protection in every inflation environment.
Therefore your goal should be a diversified investment mix that can weather different scenarios. Here are some suggestions to help you achieve that goal.
Commodities, including gold and foreign currencies, are often cited as effective inflation hedges. However, the increased risk and complexity that these investments entail offset their potential inflation protection, making them a poor choice for all but the most sophisticated investors. That leaves us with stocks and Treasury Inflation Protected Securities (TIPS).
Stocks play a prominent role in most portfolios and historically have been the primary drivers of investment returns. In addition, during periods of mild inflation, stocks tend to perform reasonably well in large part due to the risk that investors are willing to accept to earn higher returns. But high inflation can inflict serious damage on stocks.
TIPS are a powerful tool to preserve a portfolio's purchasing power, especially during periods of high inflation. These bonds rise and fall commensurate with changes in the consumer price index (CPI). Because of their high sensitivity to changes in the CPI, TIPS are arguably the most versatile inflation hedge across various inflation environments.
The inflation statistic that the government reports is called core inflation. And it excludes items such as food and energy, whose price movements are volatile and can be influenced by factors such as weather or political unrest that change quickly.
Many people have a problem with this approach because those two expenses represent a significant portion of most families' budgets. Also they understand intuitively that their cost of living is rising faster than the government statistics indicate.
My suggestion would be to track your own expenses and base your cash flow and investment plans on your own budget and not just what the government is telling you.
John Spoto, NAPFA-registered financial adviser
Sentry Financial Planning, Danvers, Mass.
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