Optional Inflation Hedges Turn in Handsome
Gains in 2010
© Sound Mind Investing | February 2011
Last year we introduced  a set of investment recommendations for those with a particular concern about the potential impact of rising inflation. Those recommendations were not presented as an integral part of the Upgrading model, and so have been labeled "optional."
Recommendations are made in five investing areas using a modified version of our momentum strategy. See the table at right for the 2010 results (based on transactions being made at the end of each month; transactions costs, if any, are not included). We also show the overall results from a portfolio divided evenly among the five areas.
These inflation hedges tend to be volatile, higher-risk investments. We call your attention to additional peformance history on our OIH page . There you will find the results, by category, from following this system over the past 15 years (1996-2010 — foreign currency is excluded because the related ETF vehicles came into existence only about five years ago.)
You'll see that, while there have been several wonderfully positive three- and 12-month periods, the worst-case results have been devastating. Not many investors can stand watching their account values drop by 40%-50% in a mere three months. The worst 12-month periods show even greater declines.
The past year was favorable because of the very real threat of rising inflation. It would seem this will continue in 2011, but there are no guarantees. So, use with caution.
REMINDERS REGARDING THE OPTIONAL INFLATION HEDGES
The goal of the Optional Inflation Hedges is to have certain sectors represented in one's portfolio that have been selected specifically to respond to a particular threat: rising inflation. Understand that the key to OIH is simply being in those sectors. It's less about which specific funds are held.
This is the opposite of some other strategies, such as Sector Rotation , where we don't care about the sector; it's all about the specific funds chosen.
Being who we are, it's difficult for us to just "settle" for average performance within those OIH sectors. So we've added an Upgrading wrinkle to try to wring a little extra return out of the strategy. But don't be confused about the primary purpose of the OIH strategy: it's basically trying to buy inflation insurance.
Given that, we've eliminated some volatile funds from being used in OIH. We don't want funds that race up and down the rankings. Rather, in OIH we want funds that are typically good representatives of their respective categories.
We think a portfolio primarily allocated to our core Upgrading strategy is the best approach for most readers, with smaller holdings optionally allocated to OIH and/or SR. Limiting any OIH and SR holdings (combined) to no more than 10%-20% of a total portfolio is generally recommended.
Some readers have noted that not all of the OIH funds are available at all brokerages (no surprise) and wonder how to respond to that. The answer is found in the Fund Performance Rankings .
In it, you'll find the four specific categories referenced on the OIH page (toward the back). Within each of these four categories, the funds included in the OIH database are marked with an arrow. Not all the funds in each group are used for OIH purposes (as explained above).
If the recommended OIH fund is closed, or not available at your broker, the FPR makes it relatively easy to select an alternate fund. Just remember to track any substitutions yourself. 
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