This investment option can provide protection against inflation

Whether transitory or not, inflation has investors rattled.

“Many clients have brought up inflation as a concern,” said Jimmy Lee, the CEO of Wealth Consulting Group in Las Vegas. “They’re hearing it all over the place.”

Inflation last month accelerated at its fastest pace in 13 years. The consumer price index rose nearly 1% in June, the largest one-month jump since 2008, the Labor Department said. Year over year, prices surged 5.4%.  

The Federal Reserve has said these price hikes are transitory and will fade over time as the economy recovers from the economic shock due to Covid-19.  

“The ‘inflation is transitory’ argument is starting to wobble,” said Greg McBride, chief financial analyst at Bankrate.com.

“Supply chain disruptions and pent-up demand are more evident than ever, but there are still some base effect comparisons to last year that won’t wash out for another couple of months.” 

To that end, investors concerned about inflation eroding the value of their money may now want to be more proactive when it comes to the fixed income portion of their portfolios.

One of the best ways to do that is with Treasury inflation-protected securities.

TIPS are issued and backed by the U.S. government like typical Treasury bonds, however, these securities come with protection against inflation.

The difference is that regular Treasury bonds could lose value over time if the interest they earn is below the rate of inflation. Currently, the bellwether 10-year Treasury bond is yielding about 1.4% — which would mean losing purchasing power if inflation hits 2%. (The same goes for the low yields on certificates of deposits, which no longer protect long-term buying power.)

Alternatively, the principal portion of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. In this case, as inflation rises, the value of the principal will rise as well to maintain its value.

For example, an investor buys $1,000 in TIPS at a fixed rate of 1%. If inflation rises by 2%, the principal will rise to $1,020. The rate will stay the same 1%, but future payments are multiplied by the new principal amount of $1,020, so interest payments are $10.20 for the year (or $5.10 every six months, since TIPS pay interest twice a year).

When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.

“If you have concerns about inflation, incorporating TIPS might make you feel better regardless of the outcome,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York.

“We have used TIPS before as an allocation on the fixed income side but not a full hedge,” said Wealth Consulting Group’s Lee.

“You can do better by adding in some other tools,” Lee advised, such as commodities, high-yield bonds and equities.

The goal is “design something you can stick with,” Boneparth added. “Nothing is an all-or-none strategy.”