Long-Term Investment Strategy Using Stock as a Hedge Against Inflation

This paper suggests an investment strategy to formulate a long-term stock portfolio. It allows the investor to specify the desired return on investment to be equal to the expected rate of inflation plus a certain premium rate. The model then helps the investor select those stocks that will provide the greatest chance of meeting that specified long-term investment goal. The formulated portfolio would generate a return exceeding the rate of inflation. Thus, the suggested model can become an effective vehicle for using stock as a hedge against inflation over the specified period of investment. A term structure model is derived to estimate long-term returns on stock investments based on short-term market information. The projected rates of return and their associated risks are included in a portfolio formulation framework to derive the optimal stock investment strategy. This approach permits the investor to set up the appropriate long-term investment strategy without involving the assessment of his risk preference. Furthermore, the decision maker is able to adjust the structure of the portfolio from time to time during the decision time frame without altering the established long-term investment objectives. An empirical testing of the proposed model is included in the paper to illustrate the effectiveness of the suggested investment formulation strategy. It is also used to compare against the strategy suggested by many practitioners where the portfolio is suggested to consist of an equal portion of ten highest-yield stocks in the Dow Jones industrial average.