How To Avoid Recessionary Effects On Your Portfolio

The Effects of Inflation: How to Manage Your Portfolio
Over time, prices for everything from corn to a new cars tend to rise. When those rises become too much to bear, investors and consumers can face difficulties because of their falling purchasing power.

An example of inflation can be seen in the United States in the 1970s. The 70's began with inflation in the single digits. By 1973-74, it had gone up to more than 10%. It peaked at more than 13% by the end of the decade. With investors earning single digit returns on stocks, and inflation coming in at double that number, making money in the market was tough.

Investing in growth stocks is also a way to recover your portfolio. Growth stocks can help you to push your portfolio beyond the point of inflation. Many argue that small caps offer much more opportunity for growth. Along with increased opportunity for growth comes increased opportunity for loss. When deciding if small caps might have a place in your portfolio consider both sides.

When it comes to protecting your money from rising inflation, there are several strategies. First is the stock market. In the past rising prices tended to be good news for equities. For fixed-income investors seeking an income stream that keeps pace with rising prices, Treasury Inflation-Protected Securities (TIPS) are a common choice. They are government-issued bonds that come with a guarantee that their par value will rise with inflation, as measured by the Consumer Price Index, while their interest rate will remain fixed. Interest on TIPS is paid semiannually. TIPS can be purchased directly from the government through the Treasury Direct system in $1000 increments with a minimum investment of $1000 and are available with 5-, 10-, and 20-year maturities. There are also several Mutual Fund Companies and Investment Companies that have exchange traded funds with a focus on TIPS.

You can also use international bonds as a way to provide income. They provide diversification too, they give investors access to countries that may not be experiencing inflation. Gold is used as a popular inflation protector, as it tends to retain or increase its value during inflationary periods. If you use technical analysis other commodities can also respond well, such as real estate, since these investments tend to rise in value when inflation is on an upswing. On the commodities side, emerging-market countries often generate significant revenues from commodity exports, so adding stocks from these countries to your portfolio is another way to play the commodities card.

The Effects of Deflation: How It Effects Your Portfolio
Deflation is less common than inflation. It appears when a lower level of demand in the economy leads to an excessive drop in prices. Periods of high unemployment and economic depression often coincide with deflation. This is what we are experincing now between 2008-2011 and perhaps beyond.

The period between 1991 and 2001 is considered Japan's lost decade and shows how devastating deflation can be. It started with collapses in both the stock market and the real estate market. The resulting economic collapse brought falling wages. Falling wages led to lower demand, which led to lower prices. The prices fell that led to the expectation that prices would continue to decline, so consumers held off on making purchases. That lack of demand caused prices to fall further and the downward cycle continued. Combine that with interest rates that hovered near zero and a depreciating yen, and it lead to economic expansion coming to a screeching halt.

On the stock side, companies that produce consumer goods that people must buy no matter what (think toilet paper, food, healthcare) tend to hold up better than other companies; these are referred to as defensive stocks and consumer staples. Dividend-paying stocks are another consideration in the stock area. Cash also becomes more popular during during deflationary times. Certificates of deposit and savings accounts are often a fit in this category.