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TIPS for Inflation Protection

By February 28, 2014No Comments

After dropping sharply during the Great Recession, inflation — as measured by changes in the consumer price index (CPI) — has begun to creep upward, averaging a little more than 2% annually from July 2009 through July 2013.1

This rate is still relatively low, but even moderate inflation can have a negative impact on the purchasing power of investments. Consider that a hypothetical investment earning 5% annually during a period of 2% annual inflation would return only 3% after inflation. The rate of return would be further reduced by income taxes.

Preserving Purchasing Power

If you want to help protect your investment dollars from inflation, you might consider Treasury Inflation-Protected Securities (TIPS). Along with the earnings potential associated with other Treasury bonds, TIPS are indexed to inflation. If the CPI rises, the principal value of TIPS increases. If the CPI falls, the principal value falls. TIPS are guaranteed by the federal government as to the timely payment of principal and interest.

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TIPS pay a fixed rate of interest twice a year based on the current principal, so the amount of interest may rise and fall. If you hold the bond to maturity, you will receive the greater of the original or inflation-adjusted principal. Unless you own TIPS in a tax-deferred account, however, you must pay federal income tax each year on the interest income plus any increase in principal, even though you won’t receive the accrued principal until the bond matures.

One convenient way to add Treasury securities to your portfolio is through TIPS mutual funds. Unlike individual TIPS, TIPS mutual funds have no maturity date and are very sensitive to interest-rate movements. Moreover, the principal value is not guaranteed. When interest rates rise, the value of underlying TIPS investments typically falls, which can adversely affect the fund’s performance.

The return and principal value of all bonds and mutual funds fluctuate with changes in market conditions. Shares, when sold, and individual bonds redeemed prior to maturity may be worth more or less than their original cost.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1) U.S. Bureau of Labor Statistics, 2013

The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2014 Emerald Connect, LLC
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