There's been much debate in investing circles over the last year about whether inflation or deflation represents a more likely threat to the future of the U.S. economy. With a recovery that's still tentative compared to previous recessions, measures designed to stimulate the economy or cut spending to rein in the budget deficit provoke warnings about their potential to create one or the other. The case for inflation As the economy has begun to recover, worries about the potential for future inflation have become widespread. The Fed has undertaken extraordinary measures to make sure there is plenty of money in circulation, but some experts worry that the increased money supply will eventually cut the dollar's purchasing power, especially if interest rates are kept at historically low levels for too long. They cite the easy availability of money as contributing to the late-1990s tech bubble and the mid-2000s housing bubble, and fear that another could be on the way. The Federal Reserve Board's monetary policy committee maintains that inflation currently is too weak to support normal economic growth, let alone launch an inflationary spiral. However, those who see inflation in our future watch for warning signs such as increased Treasury yields, particularly on longer-term bonds. Higher yields when bonds are auctioned suggest that investors are increasingly wary of tying up their money for long periods at a fixed interest rate if they feel that inflation is going to erode the buying power of those fixed payments over time. Wholesale prices also are watched closely; higher prices at the wholesale level can be a precursor of higher prices at retail (that is, if retailers are able to pass those costs along to buyers, which is not always the case). The case for deflation At first blush, the falling prices that characterize deflation [...]

Everyone knows the stock market has its ups and downs, but just what’s involved in recovering from a serious down?  If you lose 10% one year but your portfolio returns 10% the next year, are you even again? The short answer:  no.  The math of recovering from a loss isn’t quite that symmetrical.  You have to gain more than you lost to recoup all your losses.  To understand why, let’s look at a hypothetical example.  Say you have a $100,000 portfolio.  In Year 1, you suffer a 10% loss and are down $10,000.  That leaves your portfolio worth only $90,000. In Year 2, the market rebounds and your portfolio rises by 10%.  However, that 10% increase is based on a $90,000 portfolio, not $100,000.  That means a 10% return adds only $9,000 to your portfolio not $10,000, leaving you still down $1,000 from where you started.  You would actually have to earn a return of a little over 11% to get back to your original $100,000. The bigger the loss, the bigger that rebound needs to be to get you even.  For example, if that $100,000 portfolio had taken a 40% hit, as many did in 2008, you’d need almost a 67% increase to offset that $40,000 loss.  That could take several years even if stocks perform well. The challenge is compounded by investor psychology.  Adjusting your asset allocation to aim for a higher return is one way to try to recoup losses faster.  However, many investors find it difficult to take on additional risk after having watched their investments take a hit.  And there’s no guarantee that more risk will necessarily produce the desired result—at least not within the desired time frame. The lopsided nature of recovery from market losses underscores why risk management is such a key component [...]