TIPS, I bonds are smart ways to buy inflation protection

Artwork by Liam Eisenberg


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As a consumer, it’s nearly impossible to escape the ravages of inflation, which rose 9.1% in the 12 months to June, according to the US Consumer Price Index.

As an investor, however, there are several ways to hedge against continued high inflation, primarily through the purchase of Treasury Inflation-Protected Securities, or TIPS. Most individual investors are unfamiliar with the $1.7 trillion TIPS market, but these Treasury bonds deserve a place in portfolios.

Current yields are high, around 10%. While TIPS yields are expected to fall if inflation abates in the months and years ahead, yields could still be significant even if inflation runs at half the current rate. There is little reason to hold regular Treasuries which now yield around 3%, given the return potential and hedging power of TIPS.

The best way to invest in TIPS is through funds. These include exchange-traded funds such as the


iShares TIPS Bond

ETF (symbol: TIP),


iShares 0-5 Year TIPS Bond

ETF (STIP),


Vanguard Short Term Inflation Protected Securities

ETFs (VTIP), and


ADVICE Schwab US

ETF (SCHP). There are also actively managed mutual funds such as the


Vanguard Inflation Protected Securities

funds (VIPSX) and


T. Rowe Price Inflation-Focused Limited Life Bond

(TRBFX).

ETF / Symbol Cumulative return since the beginning of the year Current yield* 12 MB. Yield Assets (bil) Expense ratio
iShares TIPS Bond ETF / TIP -8.0% 10.64% 6.59% $31.1 0.19%
iShares 0-5 Year TIPS Bond ETF / STIP -1.1 10.32 5.84 12.5 0.03
Vanguard Short Term Inflation Protection Secs. / TVIP -1.2 -0.72 5.59 21.2 0.04
Fund / Symbol
Vanguard Inflation-Protected Securities Fund / VIPSX -7.8% 8.02% $36.7 0.20%

* DRY yield

Sources: fund reports; the morning star

Series I Treasury Savings Bonds offer a simple alternative to TIPS funds and now pay an interest rate of 9.62% for the first six months on bonds purchased through October.

The main disadvantage of I bonds is that individuals are limited to $10,000 in annual purchases, although investors can circumvent this limit. Interest on TIPS, I Bonds, and other treasury bills is subject to federal income tax but exempt from state and local taxes.

“Inflation is the No. 1 topic with clients,” says Dhruv Nagrath, director of fixed income strategy at BlackRock, which manages iShares ETFs. “TIPS provide a measure of inflation protection for portfolios. They increase in value with inflation.

Traditional inflation hedges such as equities and commodities have had a mixed record this year.

Most of the return on TIPS comes from an inflation component. The principal value of the bonds is adjusted semi-annually according to the consumer price index. Then there is the actual return, which can be positive or negative depending on the demand for TIPS.

While TIPS track inflation, the value of bonds can fluctuate with changes in the real yield. Longer term TIPS are more volatile.

This year, iShares TIPS Bond, with an average maturity of around seven years, had a negative return of 8% despite the positive effect of higher inflation. This is because real yields on TIPS are rising sharply, driving down bond values. The actual yield on the 10-year TIPS is around 0.5%, down from minus 1% in early 2022.

The sell-off, however, makes TIPS more attractive and increases the chances of good returns in the future, as investors are now earning a return above inflation, hence a positive real return.

Another favorable factor is that the so-called equilibrium inflation rates – or the difference in yield between inflation-protected bonds and nominal bonds – have fallen by around 0.5 percentage points over the past few years. last months. The 10-year break-even rate of inflation is now 2.3%, meaning investors will be more likely to own a TIPS with a current real yield of 0.5% than a Treasury. 10-year yielding 2.8% if inflation exceeds 2.3% in the next 10 years.

“The breakeven rate is too low,” says Rob Arnott, founder and president of Research Associates. “This inflation is not transitory.”

Arnott expects the housing component to help keep the CPI index in the high numbers over the next two years. Nagrath and others prefer short-term TIPS funds because their values ​​are less sensitive to changes in real rates.

Unlike regular TIPS, TIPS ETFs do not generate phantom income. The inflation adjustment added to the price of the bond is taxable income. Direct TIPS holders must pay taxes on this income but receive no money. TIPS ETFs pay monthly or quarterly dividends that are equal to taxable income.

TIPS can be purchased through the Treasury Direct program and banks and brokers. The Treasury auctions five-, 10-, and 30-year TIPS during the year. The reported returns of TIPS ETFs can be confusing. IShares 0-5 Year TIPS Bond is currently yielding 10%, while similar Vanguard Short-Term Inflation Protected Securities is yielding negative 0.7%. iShares returns reflect recent high inflation adjustments while the Vanguard ETF only includes real return. Both are permitted under Securities and Exchange Commission guidelines.

Treasury Savings Bonds I offer no real yield, a negative effect compared to TIPS. An inflation adjustment linked to the CPI index is added twice a year to the value of the bonds. Investors must hold the bonds for at least one year and will lose a quarter interest if redeemed within five years. But bondholders can defer paying taxes until the final maturity date in 30 years. This gives these instruments an IRA-like quality. Interest from the I-bond may be exempt from tax when the proceeds are used for educational purposes.

ETF TIPS TIPS Bonds Series I Savings Bonds
Inflation adjustment Paid monthly Paid when due Paid when due
Frequency of income payments Monthly or Quarterly Semiannually Paid when due
Exchange Traded Yes Over the counter Nope
Set due date Nope Yes 30 years
Ghost income Nope Yes Nope

Sources: Blackrock; US Treasury

“Not many people in my world recommend I bonds to clients because of the low limit on how much you can invest in them,” says John Scherer, founder of Trinity Financial Planning in Middleton, Wis.

Another reason planners aren’t pushing I bonds is that they should be held at the Treasury and not at depositories like Schwab. Planners who charge packing fees are not paid on I Bonds.

Scherer says investors can get around the $10,000 limit by also investing through trusts and small businesses that are sole proprietorships.

High and persistent inflation is a significant risk in the 2020s, and TIPS and I bonds offer investors some of the best protection.

Write to Andrew Bary at [email protected]

Garland K. Long