Inflation protection for stocks and bonds with TIPS

“Interest payments can change,” said Gargi Chaudhuri, head of iShares investment strategy, Americas, for BlackRock, as these payments are based on principal which can change with inflation.

The CPI has recently exceeded expectations. But this situation has not always prevailed.

“If you look back a decade, inflation expectations have been above inflation year after year,” said Steve A. Rodosky, co-director of PIMCO. Real Return Funds. “So people would have been better off owning nominal Treasuries.” (“Nominal” is the term used by professionals to refer to non-inflation-protected bonds.)

Perhaps the most confusing quality of TIPS is the nature of their inflation protection.

It might seem like a TIPS fund would work like hiking pants that turn into shorts: suitable for whatever (inflationary) conditions come your way. But what sets TIPS apart is the protection they offer against unexpected inflation, said Roger Aliaga-Diaz, chief economist for Vanguard.

Market prices for all assets adjust, to some extent, to reflect expected inflation. The prices of standard bonds, for example, fall to compensate for the fact that inflation has stolen some of their initial yields. TIPS prices also fall, although the crucial difference is that their inflation adjustments help offset this. (Bond prices and yields move in opposite directions.)

Whether you choose a TIPS fund in your portfolio will likely depend on your age and your inflation expectations.

Retirees and those approaching retirement might choose one because its value should be less volatile than that of other assets that can help dampen inflation, such as stocks and commodities, Aliaga said. Diaz. Vanguard’s Target Retirement 2015 fund, a so-called target date funds, allocates 16% of the value of its assets to TIPS.

Jennifer Ellison, a financial adviser in Redwood City, Calif., said her firm, Cerity Partners, currently recommends clients keep 15-20% of the bond portion of their portfolios in TIPS funds. “But we’ve been as low as 10% at times,” she said.

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