IInflation is here, and while it may be transient, investors are still weighing how to protect portfolios against rising consumer prices.
One of the most frequently used assets in inflationary environments is Treasury Inflation-Protected Securities (TIPS). In earlier eras of inflation, advisers and clients flocked to TIPS because these bonds issued by the US government are designed to respond to inflation.
Since TIPS is backed by Uncle Sam, credit risk is virtually nonexistent, making the asset class convenient for retirees and other investors looking to reduce fixed income risk. Plus, TIPS are easy to understand, even for novice investors.
“Although there are many measures of inflation, TIPS are benchmarked against a specific index: the Consumer Price Index, or CPI, a measure of the average change over time in prices paid by consumers. urban consumers for a basket of consumer goods and services, published monthly by the US Bureau of Labor Statistics ”, said Collin Martin by Charles Schwab.
Like traditional Treasuries, TIPS are fixed rate bonds, but coupon payments are determined by the underlying principal value. Another area of interest for income seeking clients is the type of return TIPS offers.
“Most of the TIPS returns are negative today. While this may surprise many investors, consider the yields on nominal (non-inflation-protected) Treasuries. The 10-year Treasury yield is still positive at 1.5%, but once the inflation rate is taken into account, this inflation-adjusted yield is also below zero, ”notes Martin.
However, just because TIPS have negative returns, it does not mean that an investor is guaranteed to lose money on these bonds. Real returns imply that investors will lose to inflation, but nominal returns indicate that even gradual increases in inflation provide some support for this type of investment.
“If inflation were on average only 1% per year, the nominal total return on this TIPS would still be positive, as the annual inflation adjustment would offset this negative annualized real return. The more inflation increases, the more the nominal total return of a TIPS can increase; the same cannot be said of the total return of a traditional treasury, ”Martin said.
This is because TIPS exchange traded funds are supported this year. Investors added nearly $ 4 billion to the ETF Schwab US TIPS (NYSEArca: SCHP) to June 25.
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