Investors wary that high inflation will erode the value of their money may want to act fast.
Inflation soared 6.8% year-over-year in November to highest rate since 1982, the Labor Department said Friday. The consumer price index, which measures the cost of a wide-ranging basket of goods and services, rose 0.8% for the month.
“Inflation is outpacing increases in household income and weighing heavily on consumer confidence, which is at a decade low,” said Greg McBride, chief financial analyst at Bankrate.com. “It is only a matter of time before it impacts consumer spending in a material way.”
However, there are tricks when it comes to preserving the fixed income portion of your portfolio.
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 1.47%. (The same goes for the low yields on certificates of deposits, which also 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.
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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 Jimmy Lee, the CEO of Wealth Consulting Group in Las Vegas.
“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.”
