Most of the folks devote their hard earned money and savings into various investment vehicles, such as the mutual funds, since they want to beat the inflation. But if you choose to save your money by burying it in jars in your back yard or by stuffing it under your bed mattress, you are most probably going be to defeated by inflation because the cost of living continues to grows but the value of your money does not (even though you may have “planted” it in the ground)! And in fact, you are likely to lose to inflation even if you save your money in a bank account or Certificate of Deposit (CD).
For instance, the average historical rate of inflation is roughly around 3.40 percent. Let us consider you are feeling financially responsible and putting your hard earned money into a CD (Certificate of Deposit), earning 2.00%, at the local bank. By doing some quick mathematics, you can easily calculate difference (3.40 – 2.00 = 1.40) and see that you are still losing to inflation by 1.40 percent.
Moreover, all this calculation does not even take into account the effect of taxes on your saved money, which would reduce your actual rate of interest (after inflation & taxes) to roughly 0.10 percent, assuming a top federal tax rate of 25 percent. Hence, in an environment of low interest rate, you can save money in a CD (Certificate of Deposit), but still value because of inflation and taxes – you are doing what is generally called “losing money safely”. The finest platform chosen by most of the people in an attempt to beat the inflation, to achieve returns averaging around 3.40 percent, is to invest in some combo of the stock and bond mutual funds.
LEARN HOW TO BUILD A PORTFOLIO OF MUTUAL FUNDS
Building a mutual fund portfolio is similar to building a house. There are so many kinds of plans, strategies, tools and building materials but each structure shares some basic features.
In order to build the best portfolio of mutual funds, you need to go beyond the sage advice, “do not put all your eggs in one basket”. A structure that can withstand the test of time needs a smart design, a strong foundation along with a simple yet effective combination of mutual funds that your well for the investor’s needs.
UNDERSTANDING THE BASICS OF DIVERSIFICATION WITH MUTUAL FUNDS
Diversification with the mutual funds is more than just putting all your eggs into different baskets. Most of the investors of mutual funds commit a common mistake of believing that spreading money among several mutual funds means they have an adequately diversified portfolio. But, different here does not imply diverse. The investors should make sure to have exposure to different categories of mutual funds.
USE GROWTH STOCK FUNDS
As the name clearly suggests, the growth stock mutual funds basically perform best in the mature stages of the fund, such as inflationary periods, of a market cycle when the economy is growing at a healthy rate. The growth plan is clearly reflecting what the companies, the consumers, as well as the investors are all doing simultaneously in healthy economies. They all are gaining increasingly higher expectations of future growth and spending more money to do it.
USE FOREIGN STOCK FUNDS
Whenever the inflation intensifies, the value of the US dollar may fall. Hence, at the time when the inflation intensifies, the foreign stock funds can turn out as an automatic hedge because the money invested in foreign currencies is translated into more dollars at home.
BEST BOND FUND KINDS FOR INCREASING RATES OF INTERESTS AND INFLATION
The bond funds are likely to lose their value in the inflationary environments as the bond prices move in exactly the contradictory direction as rates of interest, which rise along with inflation. But, an experienced investor will still diversify with bond funds and will, therefore, find the best bond funds for rising interest rates:
1. BONDS FOR SHOTER PERIOD OF TIME
The growing rates of interests cause the values of the bonds to go down significantly. But the extended the period of maturity, the more prices will drop. Hence, the shorter maturities will perform better in a rising interest rate environment.
2. INTERMEDIATE TERM BONDS
Though the maturities are longer with the intermediate term bonds, no investor can really tell what interest rates and inflation will do. For instance, even the best of fund managers supposed inflation would come back in the year 2011, which would bring along higher rates of interests and make short-term bonds more attractive. They were completely wrong and fund managers lost to index funds.
3. THE TREASURY INFLATION PROTECTED SECURITIES OR TIPS
The Treasury Inflation-Protected Securities (TIPS) or simply called Inflation Protected Bonds can do really well just ahead and during inflationary environments, which often overlap with rising rates of interests and growing economies.
CONSIDER A LADDER APPROACH TO THE CD OR CERTIFICATE OF DEPOSIT
When the rates of interests are rising, the investors of mutual funds wanting the relative safety of the Certificate of Deposits or CDs may choose to go with a ladder approach, which means the new CD’s with short redemption periods, such as one year or less, and are bought periodically, such as once a month or once in every few months, in order to capture the higher rates as they rise.
The basic principle behind this is to climb the figurative ladder progressively higher. After a period of few months, the investor’s newest CD or Certificate of Deposit will likely receive the highest rate. And whenever the rates of interests seem to be stabilizing, the investors may consider locking in the higher rates for longer holding periods.