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The Falling Dollar

Chris Farrell Dec 28, 2007

Question: How can I hedge against the falling value of the dollar? I have 400K in TIAA/CREFF, half in TIAA and the other half split between Social Choice stock/bond fund and inflation linked-bonds. I plan to retire in 2 years and am only concerned about capital preservation. TIAA/CREFF has no Euro or other international bond funds. Thanks, Chris. Dave

Answer: In one sense you don’t have to worry about the decline in the value of the dollar relative to most currencies unless you plan on traveling to, say, Europe. The dollar is weak against the Euro, and you don’t get very many Euros when you exchange your dollars at the bank. But almost everything else you do in terms of buying, borrowing, and investing is in dollars here at home.

That said, the big concern from the declining value of the dollar is that it will contribute to rising inflation pressures. Over the past 12 months consumer price inflation has been increasing at a worrisome 4.3% rate. Much of the rise comes from higher food and energy prices, but a weak dollar isn’t helping.

Inflation is the enemy of savers. Take this example from John Brennan, the head of the mutual fund giant Vanguard. “If you are 60 years old today and spend $50,000 a year to maintain your lifestyle, you would need to spend about $90,000 when you are 80, assuming a low 3% average annual inflation rate,” says Brennan. “At 5% inflation, you’d need about $133,000 a year.”

The good news is that you’re already making the smart investment to protect yourself from the declining value of the dollar and the risk of higher inflation: Inflation-linked bonds. These are fixed income securities that preserve the value of a dollar–plus interest–against the ravages of inflation. These bonds adjust to changes in the consumer price index.

The best way to preserve capital is to invest in inflation-indexed bonds, especially the ones offered by the U.S. Treasury. Right now, investors will do better owning 10 year Treasury inflation-indexed bonds versus a traditional 10-year Treasury bond if consumer inflation exceeds an annual rate of 2.3% over the next 10 years.

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