As you read this, inflation is eating away at the value of your money. Over time, American’s inflation rate has slowly eroded the value of the dollar to the point where $1 today would only have been worth 4.8 cents in 1913 dollars. Other countries and currencies aren’t immune from the devastating effects of inflation either. Even though Israel’s current inflation rate is a manageable 1.3 % (as of March 2013), levels since 2000 have (apart from a brief period in 2002) hovered between around 2% to 4%, according to figures published by the Ministry of Finance.
Deflation
The opposite of inflation is deflation. The Great Depression in 1929 is an example of deflation. As asset values fall, people hoard cash in order to maintain liquidity and be able to take advantage of the bargain assets for sale. The challenge in a deflationary period is that the holders of the cash continue to hold out for even lower asset values. This, in turn, slows an already slow economy even more. Declining profits, layoffs, and plummeting prices continue until the economy is caught in a cycle from which it is difficult to escape.
The solution
One hedge against inflationary or deflationary conditions affecting your retirement portfolio is to avoid having all your investments tied to one country’s economy (remember geographic diversification). Instead of a portfolio composed of solely of American or Israeli stocks, bonds, Treasury bills, and real estate, include global assets as part of your retirement asset allocation.
Some people recommend other diversification possibilities, such as shifting some of your retirement investments into gold, oil, natural gas, and other investments with an intrinsic value. However, these investments carry their own risks and have disappointed many investors, so make sure to check with a professional financial advisor to see if they are appropriate for you.
Another solution to inflation is keeping a portion of your investments, even during the more conservative retirement period, in growth investments. Their growth, even if slow, can serve to counteract the debilitating force of inflation
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