Decades-high inflation has fixed-income investors looking for ways to protect their buying power and the value of their investment assets, prompting keen interest in Treasury Inflation Protected Securities, commonly referred to as TIPS.
TIPS are commonly misunderstood, however, even among financial professionals. To help their clients benefit from TIPS, advisors need to understand how they work and their potential advantages, tradeoffs, and risks.
TIPS are U.S. Treasury securities whose principal amount increases with inflation and decreases in the event of deflation. That feature can make TIPS a useful hedge against unexpected jumps in prices like those in early 2022, according to FlexShares.
The TIPS market historically has been very good at pricing in near-term inflation. TIPS’ prices and yields typically start reflecting expectations for a given month’s inflation about six weeks before it’s reported, and reflect 98% of the inflation figure by the time it’s announced, on average. By the time inflation is high, it’s already priced into TIPS and too late to act on. That said, TIPS can be a valuable strategic hedge against the kind of unexpected inflation we have seen since mid-2021, according to FlexShares.
That spike in prices has drawn attention to the need to protect portfolios from inflation’s impact on income and financial assets, especially fixed-income securities. TIPS can help protect against the risk that prices may continue to rise much faster than anticipated. Investors shouldn’t count on TIPS to protect against inflation that’s simply high, and they should be prepared for this distinctive asset’s idiosyncrasies, such as its uncertain duration and the lag in reflecting monthly inflation, FlexShares said.
A diversified portfolio that includes a range of inflation-hedging assets — including dividend growth stocks, natural resources, and real estate, as well as TIPS — can help clients provide the inflation protection they need while pursuing long-term investment objectives.
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