Kiplinger: Don't Count on TIPS

Steven Goldberg, contributing columnist for http://www.kiplinger.com/ wrote an article a couple of days ago about TIPS, which are Treasury inflation-protected securities. The reason I am pointing this article out is because one of the ETFs from our balanced ETF portfolio is the iShares Barclays TIPS Bond (TIP) which closely follows the TIPS market as defined by the Barclays Capital U.S. TIPS index.

Mr. Goldberg thinks that TIPS inflation protection will likely be overwhelmed by their vulnerability to rising interest rates. Here is an excerpt from the article:

"Treasury inflation-protected securities may rank as today's most over-hyped investment product. To hear their proponents talk, TIPS will shelter you from the ravages of inflation, which does seem likely to worsen. But they forget to mention that TIPS are Treasury bonds, which are almost certain to fall in value as inflation heats up.

The problem is that inflation and interest rates often move almost in lock step. Take the worst-case scenario from recent history: As measured by the Consumer Price Index (CPI), inflation hit 13.6% in 1980, and yields on the ten-year Treasury peaked at 15.8% the following year.

TIPS protect you from inflation with one hand, but they punish you with interest-rate hikes with the other. Remember: In the strange world of bond math, when yields rise, bond prices fall. TIPS rise in value with expectations of increases in the CPI, the government's chief measure of inflation -- albeit one that's widely criticized as understating the true inflation rate. But at the same time, TIPS prices fall as the price of other Treasury bonds do.

If you buy TIPS directly from the Treasury and hold them to maturity, you'll receive the full CPI increase. If you invest through a regular mutual fund or an exchange-traded fund, you're at the mercy of the market's expectations for the CPI.

TIPS probably won't lose money when inflation heats up, but they're unlikely to make much, either. It's pure fantasy to think that putting 10% or 20% of your assets in TIPS will insulate your portfolio against inflation. If you want real inflation insurance, you'll almost certainly do better with commodities, which I'll discuss shortly."

You can read the complete are here.