With prices falling on everything from some food to plenty of real estate, your clients may have little interest in talking about ways to inflation-proof their portfolios. What's more, their desire for asset protection in the wake of the recession may also be pushing them toward portfolio moves that would be especially risky if inflation increases suddenly.
For example, James W. Coleman, founder of Coleman Financial Advisory Group in Waterbury, Conn., is encouraging clients to resist the urge to flee from equities. "Equity valuations will reflect an expanding economy more quickly than any other investment, and it won't take much to move the market up when the enormous amount of cash is teased off the sidelines," he says. "With potential returns taking place over very short time frames, investors can't afford to be totally out of stocks."
Coleman uses an ocean metaphor to illustrate the opportunity for clients. "Just as when the tide is receding, waves still hit the shore, we will see cyclical bull cycles in the secular bear market," he says.
Pitch Stocks
How can you convince clients to remain invested in equities to capitalize on those waves of opportunity? Point out that while rising inflation, like the recent spike in gas prices, can hurt profits in the short-term, because companies eventually can increase costs for consumers, inflation often has a neutral effect on stocks. So says Jeff Spitzmiller, CFA, chief investment officer of Iron Point Capital Management, a third-party money management firm based in Folsom, Calif. "Historically corporate profits have outpaced inflation," he explains. "Currently we think U.S. companies with sizeable overseas earnings or foreign companies are in the best position to succeed if inflation takes off."
Utility companies provide another alternative for equity-shy, cash-heavy investors, says Jeffrey A. Carbone, CFP, of Cornerstone Financial Partners, in Cornelius, N.C. "Utility companies are offering 6 percent to 8 percent on their dividends, a significant improvement over the banks' 1 percent to 2 percent in interest," he explains. "Clients are wary of equities, but because they are still turning on their lights and brewing the morning coffee, they appreciate that utility companies aren't going away."
To encourage clients to buy utilities now when prices are low, Carbone stresses the industry's traditional reliability and focuses on companies in his own backyard, thereby appealing to investors' psychological bias toward companies they are familiar with.
Be Cautious on Bonds
For clients still gravitating to bonds, Spitzmiller advises staying on the shorter duration end of Treasury securities, particularly as the deficit and supply of Treasury bonds increase. "In 2007, net issues of Treasury securities were $237.5 billion. In 2008, this figure was $1.239 trillion, and likely to continue moving higher going forward. This along with the potential drop in demand for these securities as foreign investors repatriate assets hurt the potential returns of Treasuries," he says. "Today, their low yields relative to historical levels also provide more downside than upside."
Of course, inflation worries can be addressed most directly with Treasury Inflation-Protected Securities (TIPS). While conventional Treasury bonds offer fixed semi-annual interest payments and a fixed principal payment at maturity, TIPS' principal values are linked to the Consumer Price Index (CPI) and adjusted every six months to reflect the effects of inflation. If the CPI inches up 2.5 percent over the course of the year, the principal value of a TIPS bond is adjusted upward by 2.5 percent and the fixed rate of interest is applied to the inflation-adjusted principal. You can invest clients in funds that specialize in TIPS or buy directly from the Treasury at www.treasurydirect.gov.
However, Carbone finds TIPS' current yield unattractive when compared to corporate bonds. "In addition to corporate bonds, we also hold a pretty good amount of international bonds, both as a hedge to inflation and a play on the U.S. dollar," he adds.
