Go through the BS and put common expressions of personal finance in plain language.
Rising inflation is pushing investors to seek a safe haven to protect their cash from declines in purchasing power.
Although imperfect, Inflation-protected Treasury securities (TIPS) are a place where they can let their money hibernate. These are bonds issued by the US Treasury whose value changes with inflation as measured by the Consumer Price Index (CPI). The principal of the bond (the initial price of the bond in the market) increases with inflation and decreases with deflation.
Like many other types of bonds, TIPS pay interest in the form of coupons twice a year at a fixed rate. What is unique is that the actual payout fluctuates since the value of principal is constantly changing.
At the end of the bond’s term – the maturity date – you’ll receive the greater of the Initial Principal or the Inflation-Adjusted Principal, which is pretty good. Normal bonds will pay you the initial capital, regardless of inflation. You can buy TIPS from the Treasury Department or a broker. It is also possible to invest indirectly through ETFs and mutual funds offered by your brokerage firm.
In theory, TIPS helps your cash flow keep pace with inflation. But if there’s anything about economics, it’s that theory and reality don’t always match.
The inflation-adjusted return of TIPS, known as the real return, is currently negative. This is because the Fed and the inflation-fearing investors have paid tons of money for more than a year, which keeps prices up and real yields down. The result: the amount you get back on the bond’s maturity date will be less than what you paid after accounting for inflation. Yields could move closer to zero as we pass the peak of inflation and the Fed begins to cut its bond purchases.
Are TIPS a hedge against inflation? Yes, but imperfect. Is there a better hedge? Let me know what you think. To learn more about TIPS, see this Charles Schwab FAQ.