Smart Ways to Inflationproof Your Retirement Portfolio

Prudent hedges keep rising prices from gnawing at your nest egg.

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TIPS have a constant coupon rate, but the interest earnings fluctuate because they are based on the inflation-adjusted principal. One caveat: The bonds' fixed coupon rate is lower than that of treasuries of similar maturity. For example, the yield of five-year TIPS was recently 1.2 percent, well below the 3.4 percent yield of a conventional treasury. The difference is called the break-even inflation rate, in this case 2.2 percent. When the break-even rate is less than the current inflation rate, as it is now, Rogé says, "TIPS should provide a higher total return" than treasuries.

You can buy TIPS at no fee directly from the U.S. Treasury in increments of $100. Mutual funds like Fidelity's Inflation-Protected Bond Fund also primarily invest in TIPS. As with any bond fund, management fees vary, so compare costs.

3. Commodities. You might be grousing about the cost of gasoline, but if you have some of your portfolio invested in a natural resources fund, you're scoring sweet returns to soothe the pump pain. Demand for raw materials such as oil, aluminum, copper, and other metals makes them a solid hedge against inflation. Spurred by global demand, particularly from China, the cost of these limited resources is rising and so, too, the fortunes of natural resource companies.

Commodities markets are cyclical and unpredictable, but they do often move out of sync with stocks. That can balance out your overall returns, says Rogé, who urges retirees to hedge against inflation by adding a dollop of these hard assets to their portfolio. The best way, he advises, is to buy a fund that holds shares of energy and natural resource companies, such as the T. Rowe Price New Era Fund. You might also opt for an exchange-traded fund such as iShares' S&P North American Natural Resources Sector, which tracks an index of commodity-producing firms.

Since mid-2003, natural resource funds have recorded an annual average return of 28 percent vs. about 7 percent for the S&P 500 index. But don't get too dazzled by those spectacular returns. During the '90s, returns averaged less than 7 percent a year while stocks soared.

4. Real estate. Of course, you don't have to be a real estate agent to know that the housing market has fallen hard in much of the country. But like commodities, real estate, especially commercial real estate, is a tangible asset—a buttress against inflation that has the advantage of often moving out of stride with stocks. That makes real estate investment trusts, or REITS, appealing, as well as ETFs and mutual funds that specialize in real estate securities. In general, REITS own commercial property and apartment buildings, not single-family houses. And landlords can raise rents as inflation creeps up.

As a result, today's paybacks are promising. So far this quarter, returns on the benchmark index of REITS are roughly 2 percent. One low-cost way to hold real estate is through the Vanguard REIT Index, which tracks the U.S. REIT market at an annual cost of 0.2 percent.

5. Expenses and taxes. Don't overlook the impact of annual fees charged for mutual fund holdings and managed brokerage accounts, as well as the tax consequences of selling investments. Mutual fund fees, for example, regardless of how minuscule, cut into investors' profits since they're deducted from fund assets. Simply put, "the higher the inflation, the bigger the impact of the drag of expenses and taxes on your portfolio," Katz says. "It's fractional, but the hit is magnified in a low-return environment."

In general, no-load funds (which charge no upfront sales commission) are cheaper to buy. Actively managed funds that trade their holdings frequently can trigger high capital-gains taxes. And they average expenses of 1.25 percent—well above the 0.89 percent expense ratio of the typical index fund, according to Morningstar.

Bottom line: For retirees, every cent counts when it comes to navigating inflationary times. But this is one area of rising costs that, with some prudent policing, you can keep from running away with you, even if inflation does.