Some TIPS for Investing in Inflation

Prices for goods and services continue to rise, even though they haven’t risen as dramatically as in previous years. You may also want to add some inflation protection in your portfolio, especially with the new tariffs on imported goods.

We thinks inflation will rise above 3% by the end of this year. He says that historically, the US and other developed nations have seen a second surge of inflation once the initial surge has subsided.

Why Inflation is Important for Bond Investors

Inflation can be bad for bonds of all types, as it reduces the value of their fixed-interest payment. In general, bonds offer fixed-interest payments which represent a certain percentage of their face value. The purchasing power of interest payments decreases when inflation and prices increase, meaning that those fixed payments can buy less.

In 1997, Treasury Inflation Protected Securities (TIPS), created by the US Treasury to help bondholders reduce the inflation risk, were introduced. The principal and interest payments of these bonds are intended to increase with inflation. These bonds are available with maturities of 5, 10, and 30 years.

TIPS: What are the risks?

TIPS are very low risk because they’re backed by full faith and credits of the US Government. They do not, however, protect bondholders against all risks. TIPS principal and interest payments would be adjusted downward if inflation gave way to deflation. Investors may wish that they had held conventional bonds. You can also lock in a real loss if you hold a TIPS that has a negative yield.

TIPS, like all other bonds, are subject to the same interest rate risk. When interest rates increase, the value of bonds will likely fall. By holding TIPS bonds until maturity in a bond-ladder, you can manage rate risk. You will receive the adjusted principal if you hold TIPS bonds until maturity.

Taxes and TIPS

Taxes on federal income are applicable to TIPS interest payments, just as they are for payments made on Treasury Securities.

The federal government taxes any increase in the TIPS principal in the year it occurs, even though you will not receive income from this increase. When the TIPS matures, or when it is sold, federal tax will only be charged on the increase in the principal for the last year. You’ll still receive the entire increase since the original purchase. TIPS, like all Treasury Securities, are exempted from state and local taxes. Investors are advised to consult with their tax advisors about their particular situation before making any decisions that could have tax implications.

Breakeven Rates: What to Watch For

Investors can use the break-even inflation rate to determine which TIPS or conventional Treasurys make sense for their portfolios. The breakeven inflation rate is the inflation rate at which both a TIPS or a conventional Treasury bond of the same maturity will deliver the same inflation adjusted return until their maturities. As an example, if the yield on a five-year TIPS was 1.57%, but the conventional 5-year Treasury bonds paid 4.10% by February 26, 2025 the breakeven rate for the 5-year bond would be 2.53%. If inflation in the future exceeds the breakeven point, then the TIPS adjustment will provide a real return higher than that of the conventional bond. If inflation is lower than the breakeven point, then the conventional bond provides a higher return.

Find Ideas

Investors who are interested in diversifying with TIPS have a choice of individual bonds, exchange-traded fund, or mutual funds. Your choice of approach should be based on your interest and ability to research your investments. It also depends on your willingness to monitor them regularly, how much money you are willing to invest and your risk tolerance. Both individual bonds and bond fund have their pros and cons. It may be best to have both. Find out more about the difference between bonds and bond funds: .

Professional investment managers also use TIPS to protect their portfolios against specific risks, according to Lars Schuster, institutional Portfolio Manager at Strategic Advisers, LLC. He says that while higher inflation may be a problem for certain bonds, TIPS exposure could help protect the value and fixed income portion of an adequately diversified portfolio.

TIPS can be purchased directly from the US Government at various auctions held throughout the year. On the secondary market, you can buy and sell TIPS of different maturities at various prices. We doesn’t charge any fees or markups for these transactions.