The government has created record in spending which include $108 trillion in unfunded liabilities for social security, Medicare and new universal healthcare benefits. This has put the nation at risk. With the interest rates close to zero, the Federal Reserve cannot take one conventional step – reducing short-term rates – to restore the weakened economy.
In this difficult economic slump or double-dip recession, politicians – with the reluctant assistance of the Fed – could opt to spend even more massively to try to jump-start the economy. The result could be stagflation: slow growth with higher inflation.
Inflation is the curse to the debt holders. But it is a blessing to the debtors – and Uncle Sam is the biggest of them – as they can pay the fixed obligations with increasingly worthless currency.
Are you scared of rising inflation? And want to make sure better returns over inflation from your investments at minimum risk? Then Treasury Inflation Protected Securities (TIPS) may be the best investment option for you.
Treasury Inflation Protected Securities (TIPS) are also known as Treasury Inflation Index Securities and Real Return Bonds (RRB). TIPS are ‘safest of the safe’. There is minimum downside risk on investing. TIPS are long-term fixed income investments protected against fluctuations in the rate of inflation.
But why use TIPS as your hedge against inflation, rather than a traditional hedge, such as precious metals? You can use both as your hedge against inflation. But always remember, precious metals like gold and silver are less than perfect hedges.
Gold and silver have performed extremely well over the last 10 years. Gold has more than quadrupled. Silver has done even better. But 20 years before that were a total disasters.
But no matter whether inflation is low or high, TIPS will protect you from the risk on your investment. How?
Here are the advantages of buying Inflation-Protected Treasuries:
Regular Interest Payments: Just like a regular Treasury bond, TIPS pay interest regularly once in six months. But unlike traditional bonds, your principal grows every year by the amount of inflation, as measured by the consumer price index (CPI). That is when inflation rate is up; value of TIPS is also increased automatically. In other words, inflation protection is available on both capital and investment. The interest paid once in every six months also increase by the amount of inflation.
Tax Benefits: The interest you receive from TIPS investments are exempted from state and local income taxes (but not federal).
TIPS are also less volatile when compared to the traditional bonds. The yield on these TIPS funds is currently about 2.5% (plus whatever inflation is going forward).
Another important reason to consider adding TIPS to your portfolio is the great portfolio diversification benefits they bring. This reduces the overall risk and / or volatility of your portfolio over time. TIPS bond yields are low or negative correlation with the performance of many other traditional investments such as stocks and regular bonds.
Rising inflation chances are good for TIPS returns, but in the short term are negative for the returns of stocks and bonds and vice versa.
TIPS can be bought in three ways:
1. Directly: You can buy TIPS directly from the U.S. Treasury or through a bank, broker, or dealer.
2. Through the Vanguard Inflation-Protected Securities Fund (VIPSX).
3. Through its ETF equivalent – the iShares Barclays TIPS Bond Fund (NYSE: TIP)
Purchasing TIPS through mutual funds offer more flexibility.
There are several advantages of buying TIPS
1. TIPS are very good for long-term investments.
2. TIPS are excellent ways to diversity your portfolio which reduces total portfolio risk.
3. TIPS are government guaranteed.
4. TIPS are less volatile than traditional bonds.
5. TIPS are useful when inflation rates are expected to move up and when economy slows down.
6. Investment on TIPS requires less active investment management thus favor both beginners and experienced investors.
Some investors complain that TIPS hasn’t done anything exciting recently. This is not true. We’ve been in the control of disinflationary forces, not inflationary ones. That will not change next week or next month.
But as the deficit keeps increasing which makes people unhappy, pressure will increase on the government to “do something.” That “something” could be a decision to inflate our way out of this mess, rather than risk the kind of deflationary spiral that Japan has suffered over the past two decades.
Keep in mind that:
- The Fed has already taken interest rates near to zero.
- Congress has already tried a huge fiscal stimulus
- The Federal Reserve has already created trillions out of thin air to mop up worthless securities.
There are chances of rise in inflation if the economy stumbles again which forces to the government to take further action, it could be even more reckless.
Some libertarians and laissez-faire capitalists will refuse to buy TIPS. But other inflation hedges sometimes don’t work. So there is no small risk taking another approach.
In total, TIPS is the only investment that guarantees a return that exceeds inflation in the years ahead. And it is in fact an essential element of your portfolio.