Ever since the FED “expanded its balance sheet,” investors have increasing become worried about the prospect of inflation. They have pored billions of dollars into TIPS and other funds in the hope that their portfolios will not succumb to the ravages of inflation—whenever it becomes a problem.

I am not so sure whether all of the alleged inflation hedges will actually perform as assumed and/or advertised. The WSJ questioned them as well in “Inflation Protection—No Guarantees:”

The threat of inflation is drifting through the collective consciousness of investors these days. But will the inflation-protection investments so many are turning to work as advertised?
…

Of greater concern is what happens to TIPS if the market or the Fed is particularly aggressive in pushing up interest rates.

If this topic is of interest to you, I suggest you read the entire article, which covers gold and commodity funds as well.

Inflation is not a concern right now, while we are still entrenched in a deflationary environment with a sluggish economy, but eventually it will be. You can better prepare yourself by not just blindly hoping that your chosen anti-inflation investments will perform as assumed, but to also follow the trends.

For example, if TIP all of a sudden starts to reverse direction sharply and heads south, use your trailing sell stop to exit. Afterwards, you can try to assess the reasons, but don’t become complacent thinking that you are prepared just because you hold an investment that allegedly protects you from inflationary forces.

I believe that we are entering un-chartered territory and no one can, with any certainty, tell you what you should be invested in. Use the long-term trends as your guide (via my weekly StatSheet) and let them tell you what areas you should deploy some of your portfolio dollars in.

You can further eliminate guess work and emotional decision making by establishing clearly defined entry and exit points, so you will be working from a blueprint ahead of time and not making decisions by the seat of your pants and/or when the (market) heat is on.

Disclosure: We currently have positions in TIP

A couple of readers already own or are considering purchases in GNMA funds. Here’s what Bob had to say:

I am not currently in any stock mutual funds. I missed the move up and I think we are close to a top. Of course, I could be wrong.

My retirement funds are currently with T. Rowe Price. What do you think about their GNMA fund (PRGMX) for someone with my conservative (and negative) outlook?

Dave had this comment:

I am 54 yrs old and am about 7 yrs away from retirement. I currently have a small portion of my retirement investments in two funds (VFIIX and VBMFX) both of which have a large portion of their assets in GNMA govt bonds. I know that GNMA bonds have a gov’t guarantee; however with the current problems with the FHA is there a great deal of risk with these two funds?

Personally, I don’t think much of any of the GSEs (Government Sponsored Enterprises) that have to rely on taxpayer money to operate. Be that as it may, we, unfortunately, have no way to look under the hood to see where the real problems lie and when they might surface.

Since all of the funds mentioned above are interest rate sensitive, they pretty much move in tandem as the chart below shows:



VFIIX held up the best during last year’s debacle and has advanced the most in this year’s economic environment.

My take is that if GNMA runs into trouble, it will be a well-known event that will not come as a surprise. Given that, there should be enough time to exit if you are implementing a trailing sell stop, as you should with all of your investments.

It will help you to identify the end of the trend, no matter what the underlying fundamental reasons, and exit safely before serious damage to your portfolio occurs. Since the masses of investors have no exit strategy, you should have no problems to liquidate when market conditions tell you to do so.

No matter what your outlook on the market, buying an investment and using sell stops is an easy way to limit any damage should your decision prove to be mistimed. There is nothing wrong with taking a small loss, but there is everything wrong with you letting a small loss turn into a big one.

Disclosure: I am not holding any positions in the funds discussed above.

I finally made it over the big water hazard and arrived safely in Germany. As usual, jet lag will be my companion for a few days, and the 9-hour time difference is challenging at times when trying to get things done. So bear with me, if my email responses are a day late.

Reader Leon had a follow up comment on the sell stop discussions of the past few weeks. Here’s what he said:

Thanks very much for your timely and insightful comments and services. I enjoy reading your comments. We are in agreement on many things.

I’m on the Institutional side of Schwab as you are. In your comments, you have addressed trailing stops many times and I agree with their use–however, Schwab Institutional doesn’t offer trailing stops. In lieu of not having trailing stops, I have to key them in and then adjust frequently or use mental stops. How do you deal with this situation?

As I have commented before, whether a custodian offers pre-set sell stops or not makes no difference to me. I track them separately on a spreadsheet and, only once they are triggered, will I place the order the next morning. There are 2 reasons for this:

1. Since I only work with day-ending prices for sell stops, there is no need to enter them prematurely.

2. You are not subjected to intra-day market noise that may not have any bearing on long-term market direction.

In other words, whether I buy mutual funds or ETFs, only the closing prices will be considered when making sell stop decisions.

Due to my travels to Germany, there will be no post today. I expect to be back on line by Tuesday.

Just about every week, I receive reader requests to comment on their current portfolio holdings. The latest came from Martin, who had this to say:

I would be appreciative if you could make any recommendations or comments on my portfolio, as follows: I am a retiree with these vanguard funds: International growth-5%, Primecap core-21%, small cap growth-5%, wellington-3%, mid-growth-2%, small cap growth-7%, Inflation protected-7%, star fund-3%, healthcare-3%, intermediate investment grade-3%, convertible bond fund-4%, intermediate bondfund-2%. I also own Tiaa-Cref: tiqrx-3%, tiilx-8%, tibdx-3% and the balance in cash and individual bonds.

Your reply would be much appreciated as to whether these funds are suitable for a 70 year old, any that should be replaced or exchanged, etc.

While I can’t give specific advice without knowing more details about Martin, I can make some general observations.

To me, it would be interesting to know if you owned this portfolio last year and held on to it through the market crash. If so, you would know that just about all of your holdings declined sharply causing you severe portfolio anxiety.

If you set up this portfolio earlier this year, then you are sitting on some nice unrealized gains. The question in my mind simply is as to whether you are planning on holding this portfolio or if you are using an exit strategy to get out of those positions that decline with the next market pullback.

There is nothing wrong with your selection of funds if your mode of operation is to follow the trends until they end and then let your sell stops be your guide as to when to exit.

On the other hand, if you are asking me if this is a well diversified portfolio to hold onto no matter what, then my answer will be no. Last year has clearly shown that a portfolio, no matter how diversified, will go down in a bear market scenario.

Don’t participate when the next down leg starts, which it will; I am just not sure of the timing. At 70 years old, you can’t afford to take the incredible risk that buy-and-hold investing exposes you to.

Reader comments are an important component of my daily blog posts. They add valuable information to the topic discussed and many times lead to more posts on related issues.

Some readers prefer to comment anonymously, which I don’t have a problem with unless this privilege is abused. This happened a few days ago when one reader addressed an issue in a way that should have been emailed to me directly for clarification. Naturally, his comment did not get published; however, he brought up a valid point, which I want to address today.

The issue most discussed over the past couple of weeks was the use of sell stops for ETFs, mutual funds and bond funds. But how about hedges? How are sell stops applied there?

Let’s review again the purpose of the hedge:

It allows us to safely establish a position “prior” to our domestic TTI signaling a Buy.

After the markets made their lows the beginning of March 09, we were able to set up a hedge during March even though our domestic TTI did not signal a Buy until June 3, 2009.

Let’s see how this hedge actually played out over the past few months and where the sell stop should be placed. Take a look at this tracking matrix for this particular hedge, which was set up for a number of clients:



[Double click to enlarge]

As you can see, during this bullish run, the short position lost 28.14%, but the long positions gained more resulting in an unrealized gain of 6.72%. The 7% sell stop will be implemented on the result of the entire hedge and not on the performance of its components.

In other words, the high gain made on 9/16/09 was +6.75% and the 7% sell stop loss will be calculated off that high number.

While this hedge averaged about 1% per month, this certainly pales in comparison with the S&P;’s +30.89%. On the other hand, the S&P;’s numbers are more of a statistical measure than anything else, because most investors certainly did not get into the market with a meaningful portion of their portfolios back in March.

As the markets confirmed their bullish trend, I dropped many (not all) of the short components for clients’ accounts in order to become net long and add to the positions. That choice strictly depended on the risk profile of the individual client.

Remember, this hedge concept may not be for you, but there are many investors who have had either very bad buy-and-hold experiences and/or are retired and prefer less of a roller coaster way of investing their monies.

I have always maintained that the comfort level an investor has with an investment methodology is far more important than the investment itself.