Raul G. from Galveston, TX asks: Hello Mitch, I’m considering investing some money in bonds since interest rates are higher. I’m curious about the Treasury Inflation Protected Securities (TIPS) that I understand will provide a buffer over inflation. What are your thoughts on this type of bond? Are they a good investment now?
Mitch’s Response:
Thanks for sending your question. There are a few important factors to consider in answering your question.
The first is categorizing TIPS or any asset class as a ‘good investment now.’ Whether or not an asset class is a good investment depends on how its risk/return characteristics align with your goals. Since I don’t know your goals specifically, I can’t tell you whether TIPS will work in your portfolio the way you want or need them to.1
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• Determining your expenses
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Speaking more generally, TIPS pay around 2% plus the inflation rate over the life of the bond. If inflation ends up being much higher than most expect, then your principal at maturity will also be nicely higher. If the opposite occurs, you likely won’t receive much above your original principal. So, what you’re assuming with a TIPS is that inflation is going to run hotter for longer, which is not necessarily a foregone conclusion. As seen in the chart below, market expectations for inflation in the next 2- and 10-year periods are relatively low:
2-Year and 10-Year Expected Inflation
There’s another risk of TIPS that you should be thinking about. It relates to the “real rate” on Treasuries, which is the nominal rate minus the inflation rate. If the real rate turns out to be higher than expected, then nominal bond yields will also go up, which means the underlying price of the bond will go down. We saw this happen in 2022, as you can see in the chart below with the real rate swinging from about -1.15% to +1.75%. In this scenario, TIPS took a significant hit in terms of annual returns.
Real Rate on 10-Year U.S. Treasury Bonds
If inflation is your primary concern, and you have a relatively lengthy time horizon of over 10 years, then I do not think investing in TIPS or fixed income in a vacuum is likely the wisest course of action. In my view, you’d be better off owning a more broadly diversified portfolio that includes stocks and different types of fixed income, like corporates and municipals in addition to Treasurys. Historically, stocks have been a very effective hedge against inflation over long periods of time.
To help better manage your portfolio, I recommend taking a look at four steps that will help give you some ideas on how to transition into retirement with confidence. In our exclusive guide, “4 Steps to Managing Your Retirement Assets5,” you will also get insight on:
• Determining your expenses
• Determining your income
• Matching your income source with your goals and time frame
If you have $500,000 or more to invest, click on the link below to get your copy of “4 Steps to Managing Your Retirement Assets5.”
Disclosure
2 ZIM may amend or rescind the “4 Steps to Managing Your Retirement Assets” guide for any reason and at ZIM’s discretion.
3 Fred Economic Data. August 4, 2023. https://fred.stlouisfed.org/series/DFII10
4 Fred Economic Data. August 4, 2023. https://fred.stlouisfed.org/series/DFII10#
5 ZIM may amend or rescind the “4 Steps to Managing Your Retirement Assets” guide for any reason and at ZIM’s discretion.
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