2. Real estate. Inflation hedging is all about assets with tangible value, and land is an obvious such asset. But housing prices do not always go up along with every type of inflation. For example, if inflation is driven by rises in oil prices, the cost of living would go up, but "that has no effect on home prices," says Toscano.
Like TIPS, real estate might not pay off if interest rates rapidly rise. "If you try to sell your house, you might be selling into a climate of high interest rates," says Toscano. Such a climate poses two problems for the home seller: First, housing prices might be declining. Second, the seller's pockets would be hit with a higher rate on the debt probably used to buy the home in the first place. The second concern is more important if you have an adjustable-rate mortgage rather than a fixed rate.
3. Gold. Over the past few years, you have almost certainly seen commercials urging you to sell your gold jewelry. Other ads hawk gold as the ultimate safe investment whose values never decline. While the gold market might be hot now, it is no sure thing for the future. "Gold is an asset class that is historically very volatile," says West. It is also not a perfectly reliable inflation hedge. The price of gold is affected by supply-and-demand factors that often have nothing to do with inflation.
Like almost all forms of investing, inflation hedging requires diversification to avoid the volatility of any one asset. Beyond gold, volatility is a problem for commodities whose prices generally—but not always—track inflation. These include agricultural goods and oil. West recommends that investors looking to hedge against inflation consider safer alternatives: mutual funds that invest in a range of commodities or exchange-traded funds that track commodity indexes. After all, inflation could come in many forms. "It could be a ramp-up in food prices or a ramp-up in precious metal prices," West says.
Another asset that can be part of a diversified inflation-hedging portfolio is bank loans. Mutual funds that specialize in bank loans invest in short-term loans packaged and sold by banks at variable interest rates. "They actually have as high of a correlation with inflation as commodities do," says West.
Hedging strategies may gain popularity in 2010 as the signs of inflation down the road begin to appear. The economy might still look far from overheated, but as Americans have learned in recent years, fortunes can change quickly.