Cash Becomes King When Deflation Dominates

When asset prices are falling - assets such as stocks, most bonds, and real estate - investors can skirt fees and beat the market averages by turning to an easy, traditional place to store wealth: under a mattress.

Cash is king in a deflationary period, because as prices fall, the purchasing power of cash grows.

But investors need not move money from banks to bedrooms yet. Deflation has yet to fire a broadside at the US economy.

Moreover, even during raging deflation an investor need not lie atop lumps of greenbacks in order to sleep well. Bonds rather than box springs are the best place to be when prices steadily tumble. Investors just need to know how to use them.

The bond market has been dangerous in recent months. When the US stock market tumbled in August, investors ravaged lesser quality corporate bonds. And "junk bonds," the lowest-rated corporate issues, went on the trash heap.

Investors abandoned stocks and riskier bonds for the bedrock of bonds - United States Treasuries. T-bonds, those with maturities up to 30 years surged in value amid speculation of an interest rate cut that eventually materialized.

Then, as part of the highest volatility in years, investors snubbed even Uncle Sam's white-bread securities in favor of short-term T-bills and notes (maturities up to 10 years).

But investors can leave the tumult to the day traders.

"The way to go is a laddered portfolio of US government bonds," says M. Carey Leahey, chief US economist at High Frequency Economics in Valhalla, N.Y. This means buying Treasuries with staggered maturities of, say, two, five, and eight years. When one matures, replace it with an eight-year note.

The Treasury Department recently began offering Treasuries of all maturities in denominations of $1,000. Brokers and banks sell them, or investors can buy directly from Uncle Sam via the Treasury Direct program (www.publicdebt.treas.gov).

For those flummoxed by bond market turbulence, take heart. The grand guru of investors, Warren Buffett, sold massive holdings in T-bonds this summer, just before the big rally.