South Florida Sun-Sentinel (Sunday)
INVESTING IN A TIME OF INFLATION
Many investors are looking for conservative investments that will protect them against inflation. The recent fall in the stock market has many investors on edge, and they are looking for safe investments that will provide some protection of their asset base.
There are a few investments expected to provide some protection, namely Series I savings bonds and mutual funds and exchange-traded funds that invest in Treasury Inflation Protection Securities (TIPS). These investments theoretically protect investors against increases in inflation because their returns are linked to the Consumer Price Index (CPI). Unfortunately, some investors in TIPS mutual funds and ETFs have found that the value of their shares dropped significantly in 2022.
Note that there is a distinction between buying TIPS directly from the Treasury at TreasuryDirect.gov and buying TIPS in the form of shares from mutual funds or ETFs. You can purchase TIPS from the Treasury in terms of five, 10 or 30 years. You may hold them to maturity or sell them before maturity. Your principal will increase in value based on the CPI. At maturity, you are paid either the adjusted principal or the original price, whichever is higher. Interest is paid twice a year at a fixed rate and is applied to the adjusted principal. So, if the principal increases because of an increase in the CPI, the interest payment would increase. However, the interest is taxable in the year earned even though you don’t receive the interest if you purchase the TIPS directly from the Treasury.
You can purchase TIPS mutual funds and ETFs from a financial institution, but they would not have the five-, 10- and 30-year terms. The advantage is that you would receive the interest paid semiannually. However, there is a major disadvantage: You no longer have the principal protection you have when you redeem the shares you purchased from the Treasury at maturity. When you purchase shares in the form of mutual fund and ETFs, there is no maturity date. Your shares will fluctuate in value and when interest rates increase, your shares will likely fall in value. This has happened in 2022, and I have received mail from investors complaining about the fall in prices. TIPS investors in shares purchased from mutual funds and ETFs are facing unanticipated losses.
The bottom line is that investors in TIPS who want to be sure their principal is protected should only purchase TIPS directly from TreasuryDirect.gov and hold them to maturity.
For example, the total return of the 10-year TIPS in 2021 was 5.5%. However, holders of TIPS mutual funds and ETFs are seeing significant losses in 2022. When interest rates are rising, the returns of TIPS mutual funds and ETFs are reduced.
Most investment advisers expect the Federal Reserve to increase short-term interest rates in 2022. So it is expected that investors in TIPS funds and ETFS will likely see a negative return on these investments.
If you had invested in these funds in prior years, you would have received good results for three and five prior years, and modest positive returns for the last year. But recent investors in these vehicles are seeing negative returns in 2022. Year-todate
returns for many of these has been -3%.
In general, for bond funds there is an inverse relationship between prices and interest rates; that is, when interest rates go up, the prices of bonds, and bond funds and ETFs, go down. However, most investors were under the false impression that, because TIPS returns also were based on the CPI, their principal would be protected, and they would be receiving a positive return. That has not been the case for short-term TIPS investments in TIPS mutual funds and EFTs in 2022.
So, again, if you are a long-term investor, you will be protected from inflation if you purchase TIPS bonds directly from TreasuryDirect.gov and hold them to maturity, or purchase I bonds and hold them for at least five years. (There are penalties if you don’t hold I bonds at least five years.) You won’t be protected if you are a short-term investor in TIPS mutual funds and ETFS. You can contact TresuryDirect.gov for more information about these investments.