The good news is that inflation seems to be under control. The Consumer Price Index fell 0.1% in June 2010, after dropping by 0.2% in May.
The bad news? Falling prices can signal deflation. In a deflationary era, real estate is worth less, stocks are worth less. Investors may suffer. Inflation hedges such as gold, commodities, and oil won’t do well.
You shouldn’t unload all of your stocks and real estate and inflation hedges after two months of falling prices. However, the news should increase your interest in high-quality fixed-income assets. If prices are falling, earning even 2% or 3% interest increases your purchasing power.
Therefore, you should allocate a portion of your portfolio to:
* Bank accounts. They’re guaranteed by the federal government, up to $250,000 per depositor per bank.
* Treasury securities. They have a federal guarantee while the interest is exempt from state and local income tax.
* Ginnie Maes. These mortgage-backed securities also have federal backing but they lack the state and local income tax exemption. Yields are higher than Treasury yields. Many mutual funds hold Ginnie Maes.
For deflation protection, extend maturities. You might buy bank CDs maturing in five years, for example, and 10-year Treasuries. That will lock in today’s interest rates, which will provide higher real returns if prices continue to drop.
