Tahoe-Truckee Market Beat: Here’s a ‘TIP’ about inflation protection
When we talk about investing in TIPS we don’t mean the kind of hot stock tip that you get occasionally from a friend or neighbor about the next stock that is going to double in value.
The kinds of TIPS we invest in are otherwise known as Treasury Inflation Protected bonds. TIPS are a relatively safe investment because they are issued by the US Treasury and are backed by the full faith and credit of the US Government.
Most bonds will drop in price if interest rates rise. If we get into an inflationary environment with rising interest rates, the payout on TIPS will increase.
TIPS pay a low coupon rate plus an inflation adjuster twice each year. The inflation adjuster is linked to the CPI, consumer price index. If we have a period of deflation and the CPI is negative the bonds will pay out less than the coupon rate. If we have some inflation and the CPI is rising, TIPS will pay out more. They can be a good way to have a safe investment, get some yield and have that yield increase during inflationary periods.
TIPS are very easy to purchase, you can use the TreasuryDirect system. They are available with very low minimum investments of only $100. The maturities available are five, ten and thirty years for new issues.
If held to maturity TIPS will re-pay the principal so an investor is not at risk of losing principal if held until they mature. They can also be sold in the open market prior to maturity, but doing so could result in a loss of principal.
One disadvantage to TIPS is that without the inflation adjustment they pay out a low coupon rate, so if inflation is low or negative, the return from the TIP will be lower than Treasury bonds with similar maturities. They are designed to work best in times of high inflation.
There are mutual funds, including ETFs or exchange traded funds, that invest in TIPS, so it is possible to purchase a fund and have a TIP portfolio with different maturities with a single investment. One of the most liquid TIPS funds trades under the symbol TIP, and has a current yield of 2.86%, which can increase with inflation of could decrease with deflation.
TIPS can be an excellent part of your portfolio if you’re fairly conservative and are forecasting inflation.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog ator 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.