How to Inflation-Proof Your Portfolio

Inflation might be on the horizon. What can you do to protect your investments?

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Morningstar recommends carving out about 4 to 6 percent of your portfolio for commodities or commodity-linked funds. Both Benz and Early like PIMCO's Commodity Real Return Fund (PCRAX), which invests in both commodities and TIPS. Benz also likes T. Rowe Price's New Era Fund (PRNEX), because of its broad exposure to inflation-sensitive natural resources such as oil, natural gas, and coal.

Add a common stock index. Simply buying high-quality stocks or investing in a stock fund, such as one that tracks the S&P 500-stock index, is another option. "The logic here is that [the value] will go down a bit when we have inflation but eventually the companies will be able to charge more and stocks will rise," Early says. "The benefit is that you're less likely to see a bubble in a stock fund if we have inflation than in some of the obvious places like TIPS and commodities."

So while inflation might be a year or two down the road, it's never too early to start shoring up your portfolio and adding some inflation-protecting supports. What that looks like depends on the variety of your existing investments. "If [inflation is] on the horizon, act now," Early says. "By the time we start seeing meaningful changes in the CPI, it might be too late to make your move." If your portfolio is particularly bond heavy, Early says inflation protection is crucial because most bonds have fixed payments that don't grow with inflation. Plus, if the Fed raises interest rates, your existing bonds lose value. However, if you have a fairly diverse set of common stocks, you might not need to do much to hedge against inflation, Early says.

The bottom line: Don't go whole-hog trying to outsmart the market and overprotect against inflation, but be prepared for the almost inevitable reality of inflation. Diversifying your portfolio and keeping a fair amount of common stocks might be enough to stave off inflation's effects, but holding some TIPS can solidify inflation protection for your portfolio as well.