If you’re like most investors, inflation is probably not the biggest — or even the fifth-biggest — worry on your list at the moment.
But that doesn’t mean it won’t come back in a major way.
Indeed, droughts are always a great time to start thinking about flood insurance.
And as I explained in a previous column, the possibility of increasing inflation is one reason I believe energy companies remain attractive at the moment.
Moreover, dividend-paying stocks inherently provide a better degree of inflation protection than their non-paying peers … especially when they consistently raise their shareholder payments!
Of course, there are also investments specifically designed to combat future inflation like I-Bonds and Treasury Inflation-Protected Securities (TIPS).
These investments are backed by the U.S. government. They are virtually guaranteed to keep pace with rising prices (albeit, as measured by the Consumer Price Index). And even in periods of deflation, you will not lose principal.
I-Bonds are officially known as Series I Savings Bonds. Like their better-known counterparts — Series EE Savings Bonds — these bonds are NOT marketable securities. That means you can’t sell them on the open market. As a result, their value doesn’t fluctuate.
In other words, unless the U.S. government defaults, you cannot lose any of your principal by owning I-Bonds.
But by holding these bonds you will earn interest — which is comprised of two components: a baseline interest rate and an inflation adjustment.
That baseline rate is back down to zero (from a meager 0.1% last period). But the latest inflation adjustment of 1.38% brings the bond’s composite rate up to 2.76% through April 30.
Obviously, rates can go anywhere from there … but we have seen many other recent periods at least exceeding 1%.
At a bare minimum, you should receive interest rates that are as good as — or possibly better than — you would receive on other comparable investments like CDs or high-yield savings accounts. On top of that, you will get other benefits such as certain tax breaks and the chance to see yields go up over time.
Meanwhile, the U.S. Treasury began selling TIPS in 1997.
TIPS are like regular Treasury bonds, except their principal is adjusted every six months to reflect inflation. The semiannual interest payments are paid at a fixed rate, but that rate is applied to the adjusted principal.
So, in essence, your interest also goes up or down with inflation as defined by the Consumer Price Index for All Urban Consumers (CPI-U), non-seasonally adjusted and on a three-month lag.
Even better, earnings from TIPS are exempt from state and local taxes. However, your payments will be treated as ordinary income by the Federal government. That’s despite the fact that you won’t receive the principal adjustments until you redeem the bonds.
This is precisely why TIPS are great for tax-sheltered retirement accounts!
TIPS come in various varieties — including 5-year and 10-year flavors. You are also free to buy and sell them on the secondary market any time you want to.
Both I-Bonds and TIPS can be bought directly through the government’s website — TreasuryDirect.gov.
However, you can also use mutual funds that hold portfolios of TIPS.
My personal favorite would be Vanguard’s Inflation-Protected Securities fund (VIPSX). Two others are American Century’s Inflation-Adjusted Bond fund (ACITX) and Fidelity’s Inflation-Protected Bond fund (FINPX). None of these funds have loads, and all carry below-average expense ratios.
One word of warning, however. It IS possible to lose principal if you sell TIPS before they mature. And when you hold them through a mutual fund or ETF, you no longer control when (or if) the underlying bonds are bought or sold. Therefore, you should expect the value of your holdings to fluctuate and also realize that capital losses are entirely possible.
Am I saying it’s the perfect time to load up on these types of investments? No.
But my family already owns some I-Bonds and I am considering adding more … while also re-considering TIPS for our retirement accounts as well as the real-money portfolio I share with my Income Superstars subscribers.
So at the very least, this is a great time to also explore the idea in your own portfolio as well.