Focused on Inflation? 3 ETFs That Could Help Protect Your Portfolio

In personal finance, inflation is the enemy. Inflation not only steadily reduces the purchasing power of money, but it also makes it hard to preserve real returns. While no exchange-traded funds (ETFs) provide a perfect inflation shield, some are designed to respond to rising consumer prices or to assets that may benefit when inflation rises.

Here are three options that may hedge against inflation, including how they work and associated risks.

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1. iShares 0-5 Year TIPS Bond ETF

The iShares 0-5 Year TIPS Bond ETF (NYSEMKT: STIP) invests in short-term U.S. Treasury Inflation-Protected Securities. TIPS adjust their principal according to changes in the Consumer Price Index (CPI), and interest payments are calculated on the inflation-adjusted amount. STIP offers a relatively direct way to protect against rising U.S. consumer prices while limiting the interest rate sensitivity typically associated with longer-term bonds. As a bonus, its 0.03% expense ratio leaves more money to invest.

However, STIP still carries risks. Its price may fall when real interest rates rise, CPI may not reflect everyone's expenses, and taxable accounts may create tax obligations.

2. Invesco Diversified Commodity Strategy ETF

Although it carries a higher total expense ratio of 0.74%, the Invesco Diversified Commodity Strategy ETF (NASDAQ: PDBC) remains a tool to help offset inflation. PDBC provides exposure to a broad basket of commodities through futures contracts. Its strategy can include energy, precious metals, industrial metals, and agricultural commodities -- areas where prices may rise when supply shortages or strong demand drive inflation higher.

Commodity funds can be risky, though. In addition to the risk of losing principal, assets may underperform expectations.

3. SPDR Gold Shares

SPDR Gold Shares (NYSEMKT: GLD) is physically backed by gold bullion, aims to reflect gold prices after expenses, and has an expense ratio of 0.40%. Historically, gold has attracted demand during periods of currency uncertainty and geopolitical stress --both of which apply to the current situation.

Like any asset, GLD has pros and cons. One advantage of GLD is the way it can make a retiree or soon-to-be retiree feel more secure about retiring into a turbulent market. Still, gold doesn't pay interest or dividends, and its price may fall despite elevated inflation.

STIP, PDBC, and GLD each address inflation through different mechanisms: indexed government bonds, commodity prices, and precious metals. Evaluate each based on your time horizon, risk tolerance, and taxes.

Most importantly, no inflation hedge is meant to replace your entire portfolio. Instead, it should be part of a well-rounded, well-diversified portfolio.

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