Media Contact
Kathy Valentine
+1 (434) 227-2177
kathy.valentine@cfainstitute.org

 

CFA Institute Investor Education: Understanding Investing and Inflation to Protect Your Future

 

Charlottesville, Va., May 20, 2009 – Most investors think of the return on their investments in nominal terms, or the stated return on an investment. A new investor education fact sheet from CFA Institute cautions that in periods of low inflation, if investors expect a corporate bond fund to yield five percent, thinking of this as a five percent return may not be particularly harmful. But when inflation increases, thinking in nominal terms can be very detrimental, especially to long-term investment planning.

 

“Individual investors are looking at their portfolios and wondering if the markets have yet hit bottom. They’re asking themselves and their financial advisors, ‘What are my next steps? How do I protect my investments?’” said Tom Collimore, director of investor education. “As someone considers his or her investment options, it is important to keep in mind the important distinction between real and nominal returns. We created this fact sheet to help Americans make more informed investment decisions.”

 

(Read the full fact sheet.) (PDF)

 

Can These Securities Meet the Inflation Hurdle?

 

• Cash/Short-term Bond Funds – Cash investments, such as savings accounts and money market funds, will often yield less than the inflation rate, reducing a portfolio’s real return. While cash serves a useful purpose, it may be beneficial to consider a high-quality short-term bond fund to meet some liquidity needs. Remember, however, that returns that seem too good to be true often entail unexpected risks, so proceed with caution.

 

• Bonds – Medium- and longer-term bonds typically do poorly in periods of higher-than-expected inflation for two reasons. First, inflation erodes the purchasing power of a bond’s fixed income stream. In addition, unex­pected increases in inflation typically result in rising interest rates, which lower nominal bond prices.

 

Collimore noted that the report calls Inflation-protected bonds “an important exception to the behavior of most bond investments in inflation­ary periods.” These bonds, Treasury Inflation-Protected Securities (TIPS), protect investors against unanticipated inflation explicitly, because they promise to pay a real rate of return plus actual inflation. While TIPS offer protection against unexpected inflation, they share with conventional bonds the sensitivity to changes in interest rates and market sentiment.

 

• Stocks – Stocks are generally thought of as good inflation hedges over the long run as companies are able to charge higher prices to offset rising costs. Stock returns, however, may lag inflation, especially over shorter horizons. “Many investors got a wake-up call about the risks of equity investing and are now questioning the appropriateness of this market,” said Collimore. “CFA charterholders are skilled in matching goals and risk tolerance for their clients. A core component of the CFA Program is developing an investment policy statement, which is an important collaboration between the adviser and client that defines how investment goals will be met.”

 

• Commodity Funds – Some investors may address concerns about inflation by investing in commodity funds, which have value that fluctuates with prices of physical goods such as agricultural products, metals, and oil. Actively managed funds within this category tend to concentrate on a narrow range of positions, and consequently can experience more volatile results than other fund types. Additionally, some funds invest in companies that produce commodities while others invest directly in the underlying commodity, which generally offers better diversification benefits.

 

In 2008, Bob Johnson, CFA, senior managing director of CFA Institute, co-authored “Can Precious Metals Make Your Portfolio Shine? (PDF),” which addressed two major investor concerns: What are the benefits of investing in precious metals and how can investors achieve a beneficial exposure to precious metals? The findings suggest that precious metals serve as an effective hedge against the typical decline in equities that occurs during an increasing interest rate environment. Investors should consider consulting with their financial adviser about the suitability of commodities for particular financial needs.

 

“In an ideal world, investors would adopt the Boy Scout’s motto: ‘Be prepared’,” said Collimore.  “Investors that provide for a range of uncertain events are more likely to meet their investment goals. Many investors use a financial advisor to help them build a portfolio that is likeliest to meet their needs in spite of possible setbacks along the way. When looking for an adviser, investors are well served by looking for CFA charterholders, who reflect the values of integrity, experience, and commitment.”

 

About CFA Institute

CFA Institute is the global association for investment professionals. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has nearly 100,000 members, who include the world’s 84,000 CFA charterholders, in 131 countries and territories, as well as 136 affiliated professional societies in 57 countries and territories. More information may be found at www.cfainstitute.org.