HoldingsTreasury Inflation-Protected Securities, or TIPS
Inflation is a fact of life: the cost of goods and services is almost always going up.
And inflation can affect the value of your assets too, wearing away at the value of your cash, stock holdings, or bonds.
Bonds and inflation
Let’s say inflation is running at 2%, which is about the rate it’s been running for the past few years. And let’s say your investments are only earning 3%, that means inflation is actually eating away at the value of your holdings, and you’ll be earning a scant 1%.*
Inflation Defense could help ward off the negative effects of inflation
Bonds are particularly sensitive to increasing inflation. Why? Because bonds typically earn a fixed interest rate–that’s right, for many bonds the rate of return doesn’t change, no matter what. So when inflation rises, it eats into a bond’s return, and often drives their prices down.
Inflation Defense and TIPS
Inflation Defense could help ward off the negative effects of inflation. It’s an investment option built around Treasury Inflation-Protected Securities, or TIPS, which are slightly different from conventional bonds. They’re bonds that factor in inflation. As their name suggests, they are Treasury bonds issued by the federal government.
But in contrast to bonds that aren’t inflation protected, the yield on TIPS will increase as inflation rises. Essentially, the face value of the bond is adjusted upwards twice a year to account for increases in the Consumer Price Index, or CPI, which the federal government uses to measures price increases on a wide range of consumer goods and services.
While the interest rate on a TIPS stays the same, the amount of interest paid increases as the bond’s principal increases.
(If deflation occurs–which means there is negative inflation–the yield on TIPS will also decrease. At maturity, however, the face value of the TIPS bond is adjusted upward to pay back the original amount. Deflation is rare, however.)
TIPS could be something to consider, to protect a portion of your portfolio against inflation, if you expect inflation to increase, as many think it will in coming months.
While you can buy TIPS directly from the federal government, you can also buy them by investing in a fund. Stash’s Inflation Defense (Ticker: VTIP), follows an index called the Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index.
What’s inside the fund?
What are the risks?
If inflation stays low, TIPs may not perform as well as conventional bonds, according to experts. Additionally, If you don’t hold the fund in a tax-efficient account, such as a traditional IRA or Roth IRA, you’ll also have to pay income tax on increases to the fund’s yield and principle.
Performance and similar funds
The fund’s share price has a -0.33% return year to date, as of March 22, 2018, according to Morningstar. In comparison, the Schwab US TIPS ETF (Ticker: SCHP) had a return of -1.80% as of March 22, 2018, according to Morningstar. Inflation Defense had a return of 0.82% in 2017, and 2.45% in 2016.
What does it cost?
- Inflation can eat away at the value of your money, and the value of bonds
- TIPs are treasuries that adjust their face value upwards to compensate for increasing inflation
- TIPs can help preserve the value of your investment when inflation rise
*Example is a hypothetical illustration of mathematical principles, and is not a prediction or projection of performance of an investment or investment strategy