By THOMAS ADAMS - 12/2/2011

Municipal bonds and real estate are the best options for investors during these times of historically low inflation, local experts say.
 
At least one money manager, however, says inflation is not so low at all.
 
"Inflation, depending on how you're defining it, is either low or non-existent," says Michael Masiello, president of Masiello Retirement Solutions in Greece. "But what we call real-family inflation is unquestionably higher than what the government is telling us."
 
The Consumer Price Index fell by 0.1 percent in October, data from the U.S. Department of Labor's Bureau of Labor Statistics shows. For the 12 months ending Oct. 31, the index gained 3.5 percent before seasonal adjustments.
 
Masiello disputes the findings.
 
"The government has an incentive, or a vested interest, in understating inflation," he says. "All of their benefits-including Social Security cost-of-living adjustments-from most of their programs and most of the monies that they spend are tied to an inflationary component.
 
"So the lower inflation number looks better; it'll cost less money and leads people erroneously to believe there's low or no inflation."
 
Anyone who goes to the grocery store or the gas pump can argue otherwise, Masiello says.
 
"In the real world, there is some real inflation," he says. "Milk is more expensive, bread is more expensive, gas is more expensive."
 
At the end of the day, Masiello says it is erroneous to attribute the cost saving for manufacturing a personal computer from the 1990s to 2010 and call that a fair representation of inflation.

Investment options
Assuming the government definition of inflation, real estate and municipal bonds are two ways to go, says Thomas Wolf, managing partner at Mengel, Metzger, Barr & Co. LLP in Rochester.
 
"Years ago, when you could earn 3 percent in a savings account or 3 percent in municipal bonds, a person would never even think about a municipal bond," Wolf says.
 
"Some people, very wealthy people, did. But the average person would just get a good savings account. Now, with inflation so low and interest rates so low, some of these longer-term government instruments-many of which may be non-taxable-all of a sudden become an alternative."
 
Daniel Loughran, senior vice president, senior portfolio manager and chief investment strategist at OppenheimerFunds Inc.'s Rochester Division at Linden Oaks, calls inflation the No. 1 public enemy for bond investors.
 
"So, generally, low inflation is very good for bondholders," Loughran says. "A bond is essentially a stream of future cash flows-the interest that you charge the borrower and then the principal being returned at maturity.
 
"High inflation actually reduces the value, or the purchasing power, of those future cash flows. So low inflation is generally good for bonds and high inflation is the worst thing for bonds."
 
Low inflation has been a constant for the last 25 years, Loughran says. But the best approach for prospective bondholders, he adds, is selectivity.
 
"Looking at the markets right now, U.S. Treasury yields are so low that, even with low inflation, they don't look very attractive," he says. "Even with low inflation, U.S. Treasuries offer investors a negative real yield."
 
Real yields or returns take account of how inflation offsets earnings over the term of an investment, Loughran says.
 
Corporate bonds, international bonds such as debt in emerging markets, and the locally managed OppenheimerFunds portfolio are better bets, he says. The Rochester division of OppenheimerFunds oversees 20 tax-exempt bond mutual funds and has assets of $28.4 billion under management.
 
"The real yields are still relatively high, and we have low inflation," Loughran says.
 
"The reason for U.S. Treasury yields providing negative real returns is still just a general concern out there among investors surrounding risk. The flight to safety is still evident in these extremely low, practically next-to-zero, yields on U.S. Treasury bonds."
 
Wolf's clients also are asking him about investments in real estate.
 
"You may not be talking about your average person, but somebody who's got a few dollars," he says. "There's only so much real estate.
 
"In a community like Rochester-and rental real estate in particular-people who may have historically been in stocks or bonds may say they're not comfortable being in that market. They might feel Rochester is a pretty steady community from a real estate perspective."
 
Rochester and Upstate New York are traditionally protected from the big ups and downs of the national economy because of slow and steady growth.
 
"If I were to buy a two-family house or a four-family apartment building and ran the numbers, the rate of return I might be able to earn on something like that-with a little bit of risk; you have to have tenants, and there's work-might be 7 to 15 percent," Wolf says. "When the stock market was chugging along, people thought they could earn 8 percent all day long and never would've thought about real estate. But now a lot of people are nervous about the stock market."
 
Wolf has taken at least two calls in the last four weeks from clients asking about real estate as a financial option.
 
"People are saying, 'How else can I invest my money?' or 'Here's what I'm thinking about doing,'" he says. "I had a client call me this week with the real estate example and say, 'Do you think I'm crazy?'
 
"Well, no, because you make a better rate of return. But there's risk. You're making an assumption that you have no vacancies. We're making assumptions that nothing major breaks. It depends on the condition of the property."

Stocks as a buffer
Masiello, meanwhile, prefers the stock market even if inflation is low.
 
"Unless a client is absolutely uncomfortable taking on some stock market risk, we're looking at large-cap, domestic, dividend-paying stocks as being the better alternative than bonds," he says. "There have to be some bonds in the equation, but a significantly smaller portion.
 
"If dividend-paying stocks can earn 2 to 3 percent or more, and there's some potential capital appreciation, we'd much rather take our chances on stock than we would on bonds."
 
Traditionally, inflation escalates during periods of economic growth, when more people are working, spending money and competing for a limited supply of goods and services. This was noted in a report earlier this year from the San Diego financial services marketing firm Emerald Connect Inc.
 
Currently, however, prices are rising despite slow economic growth, the report said. Political unrest in oil-producing nations in the Middle East and Africa has contributed to rising oil prices. Because oil is needed to produce most goods and services, higher oil prices can drive up the cost of doing business, causing companies to cut spending and payroll, pass higher costs on to customers and accept lower profits.
 
The price of corn rose 88 percent in 12 months, Emerald Connect reported. The price of wheat jumped 76 percent, and soybeans were up 37 percent.
 
The increases are because of growing demand from economies that are recovering faster than the U.S. economy, and also because higher oil prices are spurring demand for ethanol made from corn, the report said.
 
Food prices will increase as much as 4 percent this year, the U.S. Department of Agriculture estimates.
 
"As an investor, you need to be very cognizant of inflation because it will ultimately rear its ugly head," Masiello says. "That'll happen in a couple of different ways. Right now, because of the perceived artificially low inflation, you've got interest rates at an all-time low. Ultimately, we're pretty comfortable inflation or interest rates are going to go up."
 
When that happens, he predicts bonds will drop in value.
 
"And the argument long-term is, are you better off earning 1 to 2 percent in a bond, or are you better off earning 2 to 3 percent in dividends in a stock with the capital appreciation potential of stocks over time, versus the inflation component that everybody is leery of," Masiello says.
 
Stocks, he says, can serve as a buffer against inflation.
 
"The stock market gives you the better opportunity to earn more than inflation over time," Masiello says. "Inflation is kind of the silent killer. It creeps away at your purchasing power. It creeps away at what you can do. It reduces the amount of actual dollars you have, by virtue of things costing more."
 
Loughran agrees: "Some people say, 'Yeah, inflation is low but it's about to go up.' But in my view, the best protection for inflation over the long term is including equities in your portfolio. Equity stocks have a claim on profits and on the residual value of companies. That gives you a degree of inflation protection."

Commodity comfort
Commodities also are an investment option now, Masiello says.
 
"They sometimes get classified as alternate assets," he says. "Here again, there are no absolutes. Just because we look at them or discuss them or evaluate them for a client doesn't mean we do more than 5 or 10 percent in any one sector or category. That's the real caveat."
 
Gold has caught the attention of investors as well. (See page 24 for an article on safe investments.)
 
"I like (gold)," Masiello says. "I personally like to look at it. But as an asset class or an investment, what are you looking at it for? Are you looking to buy a ring? Are you looking to use it as your retirement? Are you going to chew it?"
 
He says he would look to invest only a portion of a client's portfolio in gold, perhaps 10 percent at most.
 
Investments in gold have increased significantly in the last five years, even preceding the global collapse of the markets in 2008, experts say.
 
The demand for gold reached 1,053.9 metric tons in the third quarter, up 6 percent from a year ago, and reached an all-time high of $57.5 billion in value, the World Gold Council reported last month.
 
The increase was driven by a 33 percent increase in investment demand, to 468.1 tons with a record quarterly value of $25.6 billion, the council reported.
 
"Someone says he's heard that a guy likes gold because it's going to do this and this," Masiello says. "But what he didn't understand was the guy was hawking it on an infomercial on TV or radio, and he happens to work for Goldline or whatever the gold company of the day happens to be.
 
"He's playing to fears and emotion, but as a fundamental practical matter, not a lot of people own gold. It's moving, but in very small portions."
 
Masiello recommends investing in gold and other commodities in measured doses.
 
"Sometimes we like physical, tangible commodities, but more often than not we like the stocks of the companies that are in those industries," he says.
 
For Masiello, copper, aluminum and manganese hold as much importance as gold does.
 
"In fact," he says, "I tend to like the industrial or precious metals in that area even better than I like gold."
 
Richard Gray, managing partner at Gray Locey CPA P.C. in Brighton, has a soft spot for annuities.
 
"If you've got $100,000 in your savings account now, you're making $10 a month in interest," he says. "People are asking, 'What can I do with my money?' Well, one thing that investment managers say can get you a higher guaranteed return is an annuity. So that's become the hot thing to look at."
 
An annuity is a contract with an insurance company designed to meet retirement and other long-range goals, experts say. A lump-sum payment or series of payments is made and, in return, the insurer agrees to make periodic return payments starting immediately or in the future.
 
Annuities typically offer tax-deferred growth of earnings and may include a death benefit for beneficiaries at a specified minimum amount, such as total purchase payments, the U.S. Securities and Exchange Commission says. Tax is deferred on earnings growth. But gains are taxed at ordinary income rates, not capital gains rates, when withdrawals are taken from the annuity, the SEC says.
 
If money is withdrawn early from an annuity, substantial surrender charges paid to the insurance company, as well as tax penalties, may be required.
 
Regardless of market conditions, Masiello says, inflation will be in the mix.
 
"Historically, inflation is that short period of time where the car is rolling downhill too fast," he says. "You might put your foot on the brake a little bit more than if you were normally just going up and down hills.
 
"I don't get overly nervous about inflation. I get much more concerned about government taxation. That scares the hell out of me, and I think that's scaring the hell out of Wall Street."

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