TIPS To Hedge Against Inflation

The government has created record in spending that include $108 trillion in unfunded liabilities for social security, Medicare plus new universal healthcare benefits. This has put the country on risk. With the rates of interest close to zero, the Federal Reserve are not able to take one conventional action - reducing short-term rates - to re-establish the weakened economy.

In this hard economic slump or double-dip recession, politicians - with the reluctant help of the Fed - might opt to spend still more massively to try to jump-start the financial system. The end result could be stagflation: slow growth with higher inflation.

Inflation is the curse to the debt holders. But it is a blessing to the debtors - and Uncle Sam is the biggest of them - as they can pay the fixed obligations with increasingly worthless currency.

Are you scared of growing inflation? And want to make sure better profits over inflation from your investments at least risk? Therefore Treasury Inflation Protected Securities (TIPS) could be the most excellent investment choice for everyone.

Treasury Inflation Protected Securities (TIPS) are also known as Treasury Inflation Index Securities and Real Return Bonds (RRB). TIPS are 'safest of the safe'. There is minimum downside risk on investing. TIPS are long-term fixed income investments protected against fluctuations in the rate of inflation.

But why make use of TIPS as your hedge against inflation, rather than a traditional hedge, such as precious metals? You can utilize both as your hedge against inflation. However always remember, precious metals like gold and silver are less than ideal hedges.

Gold and silver have accomplished very well over the last ten years. Gold has more than quadrupled. Silver has ended even better. But twenty years before that were a total disasters.

But no matter if inflation is low or high, TIPS will protect you from the risk on your investment. How?

Here are the advantages of buying Inflation-Protected Treasuries:

Regular Interest Payments: Just like a regular Treasury bond, TIPS pay interest regularly once in six months. However unlike traditional bonds, your principal grows yearly by the amount of inflation, as calculated by the consumer price index (CPI). That is when inflation rate is up; value of TIPS is also increased automatically. In other words, inflation protection is available on both capital and investment. The interest paid once in every six months as well escalate by the amount of inflation.

Tax Advantages: The interest you receive from TIPS investments are freed from state and local income taxes (but not federal).

TIPS are also less volatile when compared to the traditional bonds. The yield on these TIPS funds is currently about 2.5% (as well as whatever inflation is going forward).

Another important reason to consider adding TIPS to your portfolio is the great portfolio diversification benefits they bring. This reduces the overall risk and / or volatility of your portfolio over time. TIPS bond yields are little or negative correlation with the performance of many other traditional investments such as stocks and normal bonds.

Increasing inflation probability are beneficial for TIPS yield, however in the short term are negative for the returns of stocks and bonds and vice versa.

TIPS can be bought in three ways:

1. Directly: One can buy TIPS directly from the U.S. Treasury or through a bank, broker, or dealer. You can understand more about buying TIPS directly at http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_buy.htm

2. Through the Vanguard Inflation-Protected Securities Fund (VIPSX).

3. Through its ETF equivalent - the iShares Barclays TIPS Bond Fund (NYSE: TIP)

Buying TIPS through mutual funds offer more flexibility.

There are several advantages of buying TIPS

1. TIPS are very advantageous for long-term investments. 2. TIPS are excellent ways to diversity your portfolio that minimizes whole portfolio risk. 3. TIPS are government guaranteed. 4. TIPS are less volatile than traditional bonds. 5. TIPS are beneficial when inflation rates are projected to go up plus when financial system slows down. 6. Investment on TIPS needs less active investment management thus help both newbies and experienced investors.

Some investors object that TIPS hasn't done anything interesting recently. This isn't true. We've been in the control of disinflationary forces, not inflationary ones. That will not alter next week or next month.

But as the deficit keeps increasing which makes people sad, pressure will increase on the government to do "something". That "something" possibly will be a result to inflate our way out of this mess, rather than risk the type of deflationary spiral that Japan has suffered over the past two decades.

Keep in mind that: The Fed has by now taken interest rates almost to zero. Congress has by now tried a huge fiscal stimulus. The Federal Reserve has already created trillions out of thin air to mop up worthless securities.

There are chances of rise in inflation if the economy stumbles again which forces to the government to take further action, it possibly will be even further reckless.

A few libertarians and laissez-faire capitalists will refuse to buy TIPS. But other inflation hedges sometimes never work. Hence there is no small risk taking an alternative approach.

In total, TIPS is the only investment that ensures a yield that exceeds inflation in the years to come. And it is in fact an necessary element of your portfolio.


Article Source: FxTradingStock.com

About the Author

Hedging against inflation can be risky sometimes. Download FREE Weekly Wealth Letter to learn strategies about Hedging against Inflation to reduce risk on your investment. Weekly Wealth Letter is loaded with powerful resources for wealth building. Download your free copy now: http://www.weeklywealthletter.com/wwl/index.jsp?ref=uaw&arid=1

by: Greg Matthews

Total views: 37 Word Count: 939 Date: Sat, 5 Jun 2010

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