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Stock Ideas Investors Daily Edge Inflation is Coming – Protect Yourself with Treasury Inflation-Protected Securities (TIPS)
Stock Ideas Investors Daily Edge Inflation is Coming – Protect Yourself with Treasury Inflation-Protected Securities (TIPS) 
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Did you know that as of September 2007, Warren Buffet is the second richest man in the world with a net worth of around $52 Billion. The core of his strategy was investing in insurance companies, due to the large cash reserves they must keep on hand to pay out future claims. Essentially, the insurer does not own the reserve, but may invest it and keep any proceeds. |
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| Inflation is Coming – Protect Yourself with Treasury Inflation-Protected Securities (TIPS) |
| Thursday, 26 March 2009 | ||||||||
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The U.S. government is going to have to print up trillions of dollars worth of new money in an attempt to break out of this economic crisis. This excess supply of currency in circulation is going to lead to demand-pull inflation. Demand-pull inflation is described as too much money chasing too few goods. The U.S. government is heavily in debt to the tune of over $11 trillion. How will we pay this back? We will certainly not default on our debt anytime soon. It’s possible that the government could simply inflate its way out of this mess, so essentially the biggest debt ever amassed could be paid back with almost worthless dollars. The Chinese see the writing on the wall and are getting worried. For years we’ve been getting all this cheap stuff and we’ve given them paper IOUs. They will be left holding a mountain of devalued dollars and Americans will keep all the inexpensive goods we have accumulated over the years. We learned from the Great Depression that deflation is to be avoided by all means necessary. They call Ben Bernanke “Helicopter Ben” because he once referred to a statement made by Milton Friedman about using a "helicopter drop" of money into the economy to fight deflation. We have recently seen some indications of deflation during this recession, but it’s quickly being eliminated by just speeding up the money printing press. In this case, deflation ultimately leads to inflation. The Fed cut interest rates to almost nothing in an attempt to head off the deflationary effects of falling house prices and weakening consumer demand. This “reflation” shows us that the Fed is no longer focused on fighting inflation; they are now completely focused on avoiding a depression. Why is inflation bad? Well, inflation hurts people who have saved up a nest egg and those who live on a fixed-income. The same dollars buy less goods and services. Also, wages never go up as fast as inflation, so working people can experience an increase in their cost of living, without the pay raise to go along with it.
The average American household is heavily in debt, so inflation will allow them to repay their debt in devalued dollars. I once heard a story of a woman in post war Europe that paid off her entire mortgage for the same amount of money that was needed to purchase a book of matches. Knowing this, today’s 30-year fixed rate mortgages at 5.10% look really good... It’s important that you shield yourself from inflation to protect your wealth and buying power. I think the worst case scenario would be inflation rates similar to the 1970’s as we emerge from this recession. Ultimately, you can protect yourself from inflation by investing in the right hard assets like gold, silver, copper, oil and even real estate. Another great way to protect yourself from inflation is to purchase Treasury Inflation-Protected Securities (TIPS). They eliminate inflation risk - while providing a real rate of return guaranteed by the United States government. The Treasury uses the Consumer Price Index (CPI) as a guide to adjust the principal for inflation on a semiannual basis. A fixed interest rate is paid semiannually on the adjusted principal. In that way, both interest payments and the principal are adjusted for inflation. TIPS can be purchased directly from the government through its TreasuryDirect program and on the secondary market through banks and brokers. My favorite way to invest in TIPS is to buy the iShares Barclays TIPS Bond-Exchange Traded Fund. It trades under the symbol TIP. This ETF has low fees, it is very liquid, and holds a diversified portfolio of TIPS of varying maturity dates. Bottom line: Protect yourself from inflation by having some of your portfolio in TIPS, especially when it’s clear that the recession is behind us. Best Wishes, Ted Peroulakis
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