The Consumer Price Index (CPI) rose 3.3 percent last year, up from 1.9 percent in 2003, and may be heading higher. Investors who are concerned about the threat of rising inflation may want to consider Treasury Inflation Protected Securities (TIPS). These bonds, which carry varying maturities of 5- 10, 20- or 30 years, provide a U.S. government guarantee against inflation.
TIPS investors benefit from a rise in inflation because their value changes in line with the CPI. For example, buying a 10-year inflation-protected bond with a 2 percent coupon locks in a yield 2 percent above inflation. If inflation averages 3 percent over that decade, the bond’s yield will equate to 5 percent on a 10-year Treasury bond. At 4 percent inflation, you’d be earning 6 percent a year.
You can invest directly in TIPS but buying a TIPS fund is simpler and easier than buying the individual bonds from the federal government. Also, with a TIPS fund you’re getting exposure to a wider range of securities. Several mutual funds and exchange-traded funds invest exclusively in TIPS.
