Asset Allocation Based on the Inflation Trend

Inflation Indexed Bonds – Non inflation indexed bonds may provide higher capital gains than TIPS during periods of disinflation.

Commodities – should be underweighted. Only invest in commodities with growing demand and limited supply.

Gold & Silver – Under weight or avoid. Contrary to what most people think, gold and silver are not good long term investments. Their main advantage is they maintain buying power over long periods of time. Falling inflation rates are not the ideal time to own precious metals.

Real Estate- Falling interest rates can provide a great boost to real estate values. Location is a more important factor than ever with inflation rates falling.

Periods of disinflation can provide the most favorable atmosphere for a large number of investment choices. Investing during disinflation requires an asset allocation that takes advantage of falling interest rates and economic stability.

Inflation Guide During Deflation

Deflation is when general prices for goods and services decrease. In other words, deflation is when the inflation rate falls below zero to a negative number. These time periods are rare and have a high correlation with a period of economic depression or severe recessions.

Although deflation takes place only a fraction of the time compared to inflation, it is a critical period of time. Deflation destroys wealth and is the most difficult time period for investing. Time periods of falling prices offer the least amount of profitable asset allocation choices and therefore make choices during this trend more important than any other. It only takes one time of losing a majority of your wealth to guarantee falling short of your long-term investing goals.

Deflation can be caused by restrictive monetary policies, by debt, restrictive credit, or conditions where supply outstrips demand. In reality a combination of these factors usually combine with other unknown factors to cause prices to fall.

Investors who recognize a period of deflation before it happens can make asset allocation choices that minimize the harm or even profit from falling prices. The following is a general asset allocation guide for a deflationary environment. (Always check with your financial advisor to be sure an investment is right for your individual situation.)

Large-Cap Stocks – Avoid or Short.

Small-Cap Stocks – Avoid or Short.

Foreign Stocks – Avoid

Corporate Bonds – Avoid all except companies with the absolute strongest balance sheets.

Treasury and other High Quality Bonds – Overweight because of perceived safety and possible capital gains as interest rates fall.

Treasury Bills – Overweight because of safety and increased buying power as prices of goods and services fall.

Inflation Indexed Bonds – Avoid. Many Inflation Indexed Bonds also index to negative inflation.

Commodities – Avoid.

Gold & Silver – Minimal or Avoid. The only caveat here is if deflation threatens the soundness of the safest investments such as treasury bills; then people may flee to gold.

Real Estate – Avoid. One of the worst investments in periods of deflation. This also makes it one of the best opportunities at the bottom of the deflationary cycle.

Deflation is the most destructive and dangerous of the inflation trends. Investors should take special care to recognize and make the appropriate asset allocation adjustments before deflation takes hold and destroys wealth. Investing during deflation requires an asset allocation that pays special attention to capital preservation.


In reality you will rarely find time periods where you will know with certainty where the inflation rate will be in the short term. What an investor can do is assess inflation trends and the long term probabilities of each scenario, then adjust their asset allocation accordingly.

This inflation guide provides a good starting point. Asset allocation is the single largest determinant of your investment returns. Keep in mind that investments you avoid can be just as important as the investments chosen to take positions in. Use your asset allocation to adapt to the proper inflation trend and your chances of success will greatly improve.

If inflation is consistently rising, allocate more dollars to investments that benefit from inflation. If inflation is high and falling, allocate more money to the investments that benefit from falling interest rates and economic stability. And finally, if inflation starts to go negative, place more emphasis on capital preservation.

Your chances of meeting your investment goals, and achieving above average rates of return will greatly increase if you adapt your asset allocation to the current inflation trend.

This article has been republished with permission from Arbor Investment Planner.