With fear of inflation, TIPS are in abundance

Wednesday, September 30, 2009, AM | Leave Comment

In finance, the fear of inflation makes you change your investment strategies. One strategy can be to invest in exchange-traded funds – ETF – holding Treasury inflation-protected securities commonly know as TIPS. They are basically government-issued bonds.

So far this year, investors have poured in more than $17 billion into funds that invest in TIPS. That compares with estimated net cash inflows of almost $10 billion for the whole year of 2008.

To presumably get out of this financial mess, the government is borrowing heavily and spending heavily. That creates the perception that it will eventually lead to high inflation. That, potentially, could erode the value of stocks and ordinary bonds.

Some finance experts suggest that actual inflation, but not the fear of inflation, will be low and if it stays at current low levels longer than some investors expect, then TIPS may not add any sweetness or juice to such a portfolio.

Many investors do not invest in TIPS for the yields

They basically invest for the protection these kinds of bonds will provide if inflation suddenly surges. However, through September 21, TIPS have gained an average of 7.4% total return. This is quite a decent return considering that ordinary government bond funds have returned 2.6% so far this year.

Tips on buying TIPS

You can buy TIPS from banks or brokers. However, they charge a transaction fee whereas buying directly from the government avoids paying fees. Actively managed TIPS gives investors diversification. So far as management fees, they are like any other bond charging fees.

In a Nutshell
Inflation alone does not determine how well TIPS perform. Supply and demand, like in everything else, also play a role. The demand for TIPS is driven by the fear of inflation rather than actual inflation.

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