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How Much Inflation Protection Do You Need

While concerns over rising interest rates and inflation sparked a sell-off in bonds, and a spike in demand for those with inflation protection

Christine Benz 02.02.2017

In the wake of the financial crisis, many market watchers asserted that the combination of economic stimulus and the Federal Reserve's zero interest-rate policy would stoke inflation and in turn interest rates. Seven years later, however, neither scenario has panned out. While concerns over rising interest rates and inflation sparked a sell-off in bonds--and a spike in demand for those with inflation protection--following the election, both interest rates and inflation remain quite low by historical standards. The yield on the 10-year Treasury bond, for example, is just 2.4%. Meanwhile, the most recent year-over-year read on the Consumer Price Index, through November 2016, shows inflation at 1.7%, well below the long-term historical averages of 2.5%-3%. Indeed, in my recent survey of what financial experts are expecting from various asset classes over the next decade, most said that they expected inflation to remain tame--a silver lining in a return forecast that was fairly muted overall.

Yet even if inflation remains fairly benign, it's a mistake to lose sight of it as a risk factor for your investments. Investors who hunker down in fixed-rate investments, or worse yet, don't bother to invest their money at all, may buy themselves a sense of insulation from the short-term price volatility that accompanies longer-term investments. But they could be locking in real losses on their money once even modest inflation rates factored in. When investors grow concerned about inflation, prices on inflation-protective investments often move up in a hurry. By buying such investments after they've already run up, an investor runs the risk of eroding the inflation protection they provide.

But how much inflation protection does your portfolio need, really? Here's a closer look at the factors to consider when determining how much to insulate your investments from inflation, as well as some guidelines for right-sizing your positions in specific inflation-protective investments.

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About Author

Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

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