Which will it be, inflation or deflation? The problem is that no one knows for sure right now. Experts seem to be in one of two camps, a) serious inflation will come back because of all this government stimulus, or b) price deflation is coming regardless of what the government tries to do. I think there are more people who believe that inflation will be coming within the next several years than those thinking deflation is likely but it’s still up in the air.

This being the case, I find it very hard to properly allocate a long-term investment portfolio. Here’s why: In inflation, the following investments tend to do well:

a) short term bonds because as they roll you move into higher and higher interest.

b) inflation protected bonds (TIPS) or I Savings bonds

c) commodities and commodity companies.

d) equities of companies that will benefit from inflation or can more easily pass along price increases.

In deflation, the best investments include:

a) long term government bonds

b) long term corporate bonds but only those that are the most stable…think Walmart, McDonalds, Exxon, etc.

c) Cash or cash equivalents – not much yield but at least it doesn’t lose value.

Not much else is good in a deflationary environment…prices fall and so do profits which typically makes equities under perform.  You can see the dilemma. Essentially opposite types of investments are required in the two scenarios. The only “constant” in the two is short-term bonds (T-bills) and other virtual cash equivalents such as short term CDs. They will not go down in value if deflation kicks in and their yield will go up as interest rates rise.

As you can see, there’s a reason why I currently am invested in virtually all short-term debt. Yes, the yield stinks. But, until I really can see whether there will be inflation or deflation I’ll just keep my portfolio safe and flexible.