Money

Retirees worried about inflation may want to consider adding this investment to their portfolio

Martin Barraud | Getty Images

If you’re retired and worried about how inflation could hit your wallet, there may be strategies you can employ to minimize the impact.

One option could be to invest in Treasury inflation-protected securities, or TIPS. Like typical Treasury bonds, they are issued and backed by the U.S. government — which makes them a generally safe investment.

However, they operate a bit differently. And depending on how you use them, they can help protect your purchasing power.

As the U.S. continues moving back to pre-pandemic economic activity and the Biden administration’s stimulus efforts juice the recovery, inflation has been on the minds of many investors. The consumer price index rose 0.8% in April from March and 4.2% from a year earlier — the highest since September 2008 and above the expected 3.6% increase.

In addition, the Federal Reserve has indicated its willingness to let inflation run hotter than the standard 2%. And given where the economy was a year ago — largely shut down due to the pandemic, with year-over-year inflation virtually nonexistent — it’s uncertain at this point whether the jump in prices will be short-lived or more of a longer-term reality.

“It’s hard to say if inflation is a primary concern right now, but there’s a strong case to be made that inflation could continue to tick higher over the next several years as the economy heats up,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York. “So I wouldn’t discount anyone’s concerns.”

More from Personal Finance:
New teen investing accounts may deliver surprise tax bill
How to invest smartly when inflation picks up
Biden’s plans may drop a tax bomb on divorcing couples

The economy is expected to grow more than 6.5% this year, according to a recent CNBC survey of economic experts. Respondents also said they anticipate the unemployment rate will drop to 4.9% and inflation will come in at 2.5%.

So far this year, investors have put a net $23.7 billion in mutual funds and exchange-traded funds that focus on inflation-protected bonds, according to estimates from Morningstar Direct. That compares to $22.4 billion for all of 2020. Altogether, there’s about $236.3 billion or so invested in those funds.

So how do they work? TIPS investors receive regular interest payments (twice a year) based on the so-called par value (face value) until the security matures, at which point you get back your principal.

However, that amount increases with inflation (or decreases with deflation), as measured by the consumer price index. The changing yearly value is intended to maintain the TIPS’ purchasing power over time. And if the principal rises, so do your interest payments.

In contrast, typical Treasury bonds may lose value over time due to inflation, unless the interest they earn is above that rate. Right now, the bellwether 10-year Treasury bond is yielding about 1.6% — which means you lose purchasing power if there’s a sustained inflation rate of even 2%.

“I am not a fan of locking in at 1.5% or 1.6% when that’s below the Federal Reserve chairman’s target inflation rate of 2%,” said CFP Clark Kendall, president and CEO of Kendall Capital in Rockville, Maryland.

Kendall said he uses TIPS for short-term needs — up to about three years. 

“You have safety and protection of your principal,” Kendall said. “But I don’t think TIPS are good long-term … for maintaining purchasing power.”

For, say, 10 years or 15 years out, other investments — including dividend-yielding stocks — are generally better tools for beating inflation, Kendall said.

You can purchase TIPS directly from the U.S. Treasury or through a mutual fund or ETF that invests in them. Just keep in mind that the fund’s expense ratio would eat into your returns.

TIPS also aren’t necessarily great investments if you’re in search of income, because their yields are below non-inflation protected bonds, Boneparth said.

“It’s about protecting purchasing power,” he said. “If there’s no inflation, you won’t realize any of the benefits of owning TIPS.”

Source

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top button