Editor's Note: Keith Fitz-Gerald is Investment Director of Money Morning and The Money Map Report.

Right now, there’s more than $9.5 trillion in cash on the sidelines -- or more than twice the amount of money currently invested in stock mutual funds, according to MoneyNet.inc and the Federal Reserve. Private equity firms alone are believed to hold as much as an additional $1.3 trillion.



While I’ve always doubted that the “money on the sidelines” argument is really all it’s cracked up to be, one can hardly argue with a recently released report from Harris Private Bank of Chicago (part of the US arm of the Bank of Montreal (BMO), which notes that, for 2 years, stocks have rallied whenever money-market assets have exceeded 25% of the S&P 500's capitalization. According to the Los Angeles Times, that figure is now 43%, down from 58%, after having peaked in December -- and that’s even after the 30%-plus run-up in the S&P 500 since March.

What’s interesting is that many investors holding large cash positions view their money as an asset, though it’s really more of a liability at this stage of the game. Some might take issue with that statement; after all, cash -- correctly deployed -- can allow an investor to sidestep the worst stretches of a financial crisis, like the one from which we’re currently attempting to extricate ourselves.

But when the markets are as beat-up as they as they have been, history suggests there’s probably more upside than downside -- even if we haven’t bottomed out yet. And there’s a broad body of research to support that contention -- including our own newly created LIBOR/Sentiment/Value (LSV) Index (published as a part of my firm's monthly investment newsletter). There are also datasets widely published by others, such as Yale economist Robert J. Shiller. Shiller found that, when you look at 10-year periods of Price/Earnings (P/E) data dating all the way back to 1871, the markets tend to rise when the average P/E is low, as it is right now. Conversely, when the average P/E values are high -- as they were in late 1999, and again in 2007 -- a decline in stock prices is much more likely.

There are obviously no guarantees that history will repeat itself. But if it does, the same data implies we could see real returns of 10% a year or more “for years to come,” as Shiller noted in a recent interview with Kiplinger’s Personal Finance. My own research seconds the general-market-increase theory, but I’m much more conservative in my expectations, and think that returns of 7% are more likely.

Perhaps what’s more important right now is that inflation typically accompanies growth -- and with a vengeance. And that means that investors who are sitting on cash “until the time is right” may have their hearts in the right place -- but they're relying on the wrong protection strategy.

My recommendation is a 4-part plan that can help lock in the expected returns you want, while also protecting your cash from the ravages of inflation.

Let’s take a close look at each of the 4 elements of this strategy:

1. First, protect your cash with Treasury Inflation Protected Securities (TIPs). Even though the trillions of dollars the Fed has injected into the system seem to be having some effect on the critically ill patient the US central bank is trying to fix, we’re likely to pay a terrible price in the future. Forget the hyperinflation scenario so many people are hyping at the moment. While that’s certainly possible, it’s not probable. However, what is likely is a dramatic realignment of the dollar and a general increase in worldwide living expenses.

US investors who primarily hold US assets may want to consider something as simple as the iShares Barclays TIPS Bond Fund (TIP) to offset this risk. The TIP portfolio is full of inflation-indexed securities, but it also offers a healthy 7.46% yield. If you’ve got international exposure, you may also want to consider the SPDR DB International Government Inflation Protected Bond ETF (WIP). It’s a collection of internationally diversified government-inflation-indexed bonds that provides similar protection. Make sure you talk with your tax advisor about both, though. Depending on your tax situation, you may find that, due to the tax liability on inflation-related accretion, these are generally best held in tax-exempt accounts. 2. Own some gold, but don’t go crazy. Despite widespread belief to the contrary, gold has never been statistically proven as an inflation hedge. But the yellow metal has proven a great crisis hedge because of the 10:1 relationship between gold prices and bond coupon rates -- which are obviously directly related to inflation.

Over time, the 2 move in such a way that having $1 for every $9 in bond principal can help immunize the value of your bond portfolio.So to the extent that you own gold, do so not because you expect it to rise sharply, but because it will offset the inflationary damage to your bonds. A good place to start is the SPDR Gold Trust (GLD) because it’s tied directly to the underlying asset without the hassles or risk associated with owning and storing your own bullion.

3. Consider commodities. It’s too early to tell if the so-called “green shoots” everybody's so excited about are little more than weeds. Therefore, it makes sense to concentrate on picking up resource-based investments. History shows that these things are less susceptible to downturns, but more importantly, rise at rates that far exceed inflation when a recovery begins in earnest.

I prefer companies such as Kinder Morgan Energy Partners LP (KMP) that are less dependent on the underlying cost of energy than they are on actual growth in demand. That way, if energy prices don’t take off immediately for reasons related to deflation or stagflation, those will still benefit from demand growth. It’s a fine point, but one that merits attention for serious investors. Incidentally, KMP yields an appealing 8.68% at the moment.

4. Short the dollar to hedge your bets still further. Not only is the government going to borrow nearly 4 times more than it did last year, but when you add the total federal fiscal obligations to the picture, our government owes nearly $14 trillion. This makes the dollar, as legendary investor Jim Rogers put it, “a terribly flawed currency” liable to fail at any time.

To ensure you’re at least partially protected, consider the PowerShares DB US Dollar Index Bearish Fund (UDN), which will rise as the dollar falls. It’s essentially a big dollar short against the European euro, the Japanese yen, the British pound sterling and the Norwegian kroner, among other currencies.

In closing, there's one additional point to consider. You rarely get a second chance to do anything, especially when it comes to investing. So act now before the markets make it cost-prohibitive to protect yourself. When the economic recovery gets here, you’ll be glad you did.