That's because rising inflation makes every dollar in corporate earnings worth less. And it raises costs for raw materials and labor - which also shrinks corporate earnings.

So how can you insulate yourself from inflation's toll on stocks?

The most obvious way is to sell your stocks and stock-holding mutual funds if you think rising inflation will drive share prices down. This is what short-term traders do, and that's why the markets have recently been whipsawed by inflation news.

You could sell everything right now. Or you could give your broker a "stop-loss" order to sell automatically if prices fall to a given level.

Or you could keep your investments but hedge against downturns with "short sales." That means borrowing stock from your broker, selling it at today's price, and hoping to pay him back with shares bought later for less. Your profit would be the difference between today's sale price and tomorrow's purchase price - so you would make money if share prices fell.

Those strategies look fine on paper, but few of us are good enough to accurately forecast the market's peaks and valleys. Sales can be self-defeating. You may find yourself on the sidelines missing the gains from an unexpected rebound, and you would be betting against the market's long-term upward trend.

Another approach has become increasingly popular: insuring holdings by playing the options or futures markets.

Imagine that instead of keeping your $50,000 in the mattress, you invested in an index-style mutual fund designed to match the performance of the Standard & Poor's 500 index.

You could insure against loss with "put" options traded on the Chicago Mercantile Exchange called E-minis. A put contract gives its owner the right to sell a given block of shares anytime over a certain period at a set price.

E-mini contracts track the S&P 500, and are worth $50 for every point in the index. With the index currently around 1,250, a single contract would, therefore, let you control S&P 500 stocks worth $62,500. So one contract would be enough to offset losses on your index fund.

If the index fell, say, 10 percent, you probably would make around $3,100 on this contract. That's because it would allow you to, in effect, sell S&P 500 stocks at today's price while simultaneously buying them at tomorrow's lower price, pocketing the difference.

Unfortunately, to get a put contract good through early September, you'd pay a $1,400 "premium," much like the premium paid for any insurance policy. Were stocks to rise instead of fall, you would have spent that money but made nothing on the contract.

Clearly, it would be too expensive to use put options to fully insure your investments all the time, although you could buy partial insurance much more cheaply. (For a primer on E-minis and other futures and options products, go to http://www.cme.com/files/EQ004_Eminis.pdf.)

So what's the alternative?

To do nothing. Stocks, in fact, are an excellent hedge against inflation - if they are held for the long term.

Although inflation hurts companies by pushing prices of raw materials and labor up, it helps by allowing them to charge more for the products and services they sell.

Over the long term, profit tends to rise with inflation, lifting stock prices. In the 20th century, for instance, stocks' annual returns averaged around 10 percent, while inflation was 3 percent. With inflation taken into account, bonds make only 2 percent or 3 percent a year; cash, nothing.

So let's let the short-term traders agonize over inflation news. For us long-term investors, the best strategy is to ignore it.

By Jeff Brown