My finance view

One steady bit of good economic news: Inflation remains near zero. So who would want to pay extra these days to add a dose of inflation protection in their portfolio?

Plenty of people. It turns out sales are hot for Treasury Inflation-Protected Securities, a common hedge against rising prices known by their acronym TIPS.

New money from investors and market gains have boosted total assets in mutual funds investing in TIPS nearly 36 percent so far this year, according to Morningstar Inc.

It’s part of a broader shift by many investors who have been scared away by stocks, despite the market’s hefty rebound from its March low. They’ve been piling into the greater safety of bonds, and TIPS — while not without risk — are about as safe as you can get.
The value of the underlying investment in TIPS rises with inflation, providing an additional layer of protection beyond what Treasury bonds offer.

Hardly anyone expects inflation to re-emerge as a big threat anytime soon, so TIPS aren’t necessarily the best short-term investment. But historically low interest rates and the federal government’s growing deficit are expected to drive prices higher, especially once the economy truly gets back on its feet and spending rebounds.

Here are some common questions and answers about TIPS:

How do TIPS work?

Introduced by the government in 1997, TIPS are a type of Treasury bond — investments that are super-safe, provided you believe the government will continue to make good on its credit obligations.

TIPS adjust their yield based on changes in the Consumer Price Index. The principal in TIPS adjusts every six months. The so-called "coupon" rises when inflation grows, and decreases in the less-likely instance of deflation. When the bond matures, you’re paid the adjusted principal or the original principal, whichever is greater. TIPS are sold in maturities of five, 10 and 20 years.

Investors in "nominal" Treasury bonds get a fixed rate of return if they hold the bonds until they mature. For example, 10-year Treasury notes are now yielding about 3.32 percent per year.

On the other hand, 10-year TIPS are yielding 1.55 percent, which doesn’t seem so good, until you consider what havoc inflation might wreak fast pay day loans. The difference — or "break-even rate" — between those two numbers is 1.77 percentage points. That suggests investors are expecting inflation will average 1.77 percent per year over the next 10 years. So if inflation exceeds that amount and erodes Treasuries’ current 3.32 percent yield, TIPS investors will be glad they paid for the protection.

Inflation had historically averaged 2 to 3 percent until falling to near zero when the market tanked last fall and deflation fears set in.

How have TIPS’ values held up lately?

Inflation and interest rate expectations are constantly changing, which is reflected in the prices traders are willing to pay for TIPS. Lately, TIPS have generally been seen as a good deal. Mutual funds investing in TIPS have returned an average of 8.63 percent so far this year, according to Morningstar. That puts TIPS in the middle of the performance pack among fixed-income fund categories.

How can I buy TIPS?

TIPS are available for purchase from the Treasury at http://www.treasurydirect.gov to avoid brokerage fees. If you’re not sure you can keep the bond until maturity and are nervous about managing your investment over time, you can buy into a mutual fund that focuses on TIPS, or an exchange-traded fund. Like TIPS mutual funds, TIPS ETFs hold baskets of TIPS with varying maturities but can be traded like a stock.

TIPS appear to carry little risk. Is that the case?

Any bond is subject to risk from rising interest rates, and TIPS are no exception. If the Fed boosts interest rates faster than inflation grows, or before inflation sets in, TIPS’ values will erode.

They also can be hit in a falling market, as happened last fall. Many institutional investors had to come up with cash to meet clients’ orders to pull out their money, forcing them to sell their most liquid investments. TIPS often fit the bill, and massive TIPs sales reduced prices. But as seen this year, they’ve bounced back.

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