TIPS can provide investor protection against inflation

Whether transitory or not, inflation is shaking investors.

“Many clients have raised inflation as a concern,” said Jimmy Lee, CEO of Wealth Consulting Group. in Las Vegas. “They hear it everywhere.

Inflation accelerated last month at its fastest rate in 13 years. The consumer price index rose nearly 1% in June, the biggest month-over-month jump since 2008, the Labor Department said. Year over year, prices jumped 5.4%.

The Federal Reserve has said these price increases are transient and will subside over time as the economy recovers from the economic shock from Covid-19.

“The ‘inflation is transitory’ argument is starting to falter,” said Greg McBride, chief financial analyst at Bankrate.com.

“Supply chain disruptions and pent-up demand are more evident than ever, but there are still base effect comparisons to last year that won’t go away for a few months. ”

To that end, investors concerned about inflation eroding the value of their money may now want to be more proactive about the fixed income portion of their portfolios.

One of the best ways to do this is to use inflation-protected Treasury securities.

TIPS are issued and guaranteed by the US government like typical Treasury bills, however, these securities have inflation protection.

The difference is that regular treasury bills could lose value over time if the interest they earn is less than the rate of inflation. Currently, the 10-year Treasury bill is earning around 1.4%, which would mean a loss in purchasing power if inflation reached 2%. (The same goes for the low yields on certificates of deposit, which no longer protect purchasing power in the long run.)

Alternatively, the main part of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. In this case, as inflation increases, the value of the principal will also increase to maintain its value.

For example, an investor purchases $ 1,000 of TIPS at a fixed rate of 1%. If inflation increases by 2%, the principal will rise to $ 1,020. The rate will remain the same at 1%, but future payments are multiplied by the new principal of $ 1,020, so the interest payments are $ 10.20 for the year (or $ 5.10 every six months, since TIPS pays interest twice a year).

When a TIPS expires, you receive the Adjusted Principal or the Initial Principal, whichever is greater.

“If you have concerns about inflation, integrating TIPS might help you feel better regardless of the outcome,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York City.

“We’ve used TIPS previously as an allocation on the fixed income side, but not full coverage,” said Lee of Wealth Consulting Group.

“You can do better by adding other tools,” Lee advised, such as commodities, high yield bonds and stocks.

The goal is to “design something that you can stick with,” Bonparth added. “Nothing is an all or nothing strategy.”