A Strategy for the Next Ten Years

09/16/2010 1:30 pm EST

Focus: MARKETS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, publisher of the Forbes/Lehmann Income Securities Investor, says investors should prepare their portfolios for a new wave of inflation down the road.

I read [recently] that the Dow Jones Industrial Average shows a net loss of 0.9% for the last decade ending December 2009.

Are we at a bottom just before a massive rally, or are we at a Business Week moment when the headline reads “The Death of Equities,” which today reads as “The Hindenburg Effect”?

Either way, it begs the more important question of where investors go for long-term safety and income. The next decade calls for a more targeted investment approach.

Traditional refuges—home equity, stocks, mutual funds, variable annuities, and [certificates of deposit]—promise little hope of long-term viability. Even our favorite, fixed income, shows real vulnerability given the inflation outlook.

Inflation, arguably, may not come tomorrow, but come it must. There is just no other solution to the many budgetary problems faced by government at all levels around the world. I am saying, in short, that inflation will occur because governments need it to occur.

Here, then, is my list of broad categories of investments individuals should position for the long run.

1. Gold. There is only about $5 trillion of gold in existence, and only small net additions to the supply occur each year. Since I expect all currencies will be debased, you want an asset that can’t be. For wealth preservation, there is no substitute.

2. Adjustable-rate or “step-up” debt. These are securities whose interest payment is tied to some index such as the consumer price index, LIBOR or a Treasury rate, plus a fixed component. They should have a floor rate (usually 3% or 4%) and may have a ceiling rate as well. The step-up variety offers a sweetener rate for the first few years.

In selecting these securities, pay close attention to assure they aren’t called away just when you need them the most.

3. Energy funds and master limited partnerships (MLPs).  Experience has shown that oil has adjusted very well for inflation over time. Unfortunately, most oil investments get dragged down, because much of what comes out of the ground with the oil is natural gas, and it has done poorly. Buy them anyway for their high cash dividends and, in the case of MLPs, their tax-preference status.

4. Convertible securities. Convertible bonds and preferred [shares] paying 5% or more offer decent returns and a variable amount of inflation protection. Some issues, where the conversion value is well below the current market price of the common stock into which it converts, offer yields of 7% or more. They still offer some inflation protection should hyperinflation occur. Pick companies in industries that can thrive despite inflation, such as commodities and real estate.

Take advantage of [today’s] lower capital gains taxes to [move] your portfolio into the above asset categories. This is not a change you need to make overnight, but it should be a long-term direction for restructuring your portfolio.

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