Inflation’s up—what to know about TIPS and I bonds

For years, my inbox has operated as a good barometer of the financial aspirations and anxieties of everyday investors. With all due respect to the wonderful PR professionals of the world, I don’t mean my work email.

Everyone in my life knows me as a personal finance guy. So when something goes on in markets that inspires exuberance or fear, my phone buzzes. During the Covid-19 stock market crash, they asked me if they should sell (no). During the meme stock craze, they wondered whether they should go all-in on GameStop (no). At one of crypto’s highs, they floated a plan to all get rich from an altcoin tied to the Spanish soccer league (no comment).

So naturally, given last week’s headlines about the inflation ticking back up, a friend reached out to ask about his savings. “What’s the consensus on TIPS these days?” he asked. “What about I bonds?”

I told him that both Treasury Inflation-Protected Securities and Series-I savings bonds were backed by the full faith and credit of the U.S. government, meaning that they posed virtually no risk of default. I added that whether or not they were suitable for him depended on his particular goals. “But hey,” I added, “I’m happy to ask some financial pros.”

The consensus among them, it turns out, was that assets aimed at preserving your purchasing power during times of inflation could be useful portfolio tools — but that making major portfolio moves in response to short-term news is usually a shaky idea.

“Inflation protection should not be something people suddenly bolt onto a portfolio because inflation made headlines that morning,” says Jacob Cuthbert, a certified financial planner in Washington, Pennsylvania.

Over any given period, the gap between the interest rate you’ll receive owning a Treasury bond to maturity and the rate on a similarly dated TIPS is known as the breakeven rate. You can currently get a 4.48% rate on a 10-year Treasury and 2.13% rate on a 10-year TIPS, a difference of 2.35%. Should average inflation run above 2.35% over the next decade, you’d come out ahead owning TIPS.

The most recent inflation reading saw prices rise 4.2% in May from a year earlier. That’s up from a 3.8% year-over-year rise in April and well above the Federal Reserve’s 2% target for annual inflation.

I bonds

These government-backed bonds pay a fixed rate throughout the life of the bond plus an inflation-based rate that adjusts every six months based on changes in the CPI. Newly purchased I bonds bought between now and Oct. 31 pay a 4.26% composite interest rate, the result of adding the inflation-adjusted rate to a fixed rate of 0.90%.

Unlike many other types of bonds, I bonds aren’t available to buy or sell on the secondary market. That means they’re not susceptible to price fluctuations based on investor demand or movements in interest rates.

There are some quirks that come with these securities, however. You can’t redeem for a year after purchase, and if you redeem them within the first five years of buying, you’ll owe a penalty equal to three months’ interest.

You can buy no more than $10,000 worth of I bonds electronically in a calendar year (though you can purchase an additional $5,000 in paper bonds using your federal tax refund). You generally must purchase I bonds through the Treasury’s website, which can be tricky, especially if you don’t already have an account. TIPs can also be purchased directly from Uncle Sam, but you can also buy them through your brokerage or hold them through an exchange-traded fund.

Financial pros generally recommend stashing any money you’ll need right away — such as an emergency fund — in a high-yield savings account.

For money you’re hoping to spend over a short horizon such as, say, a down payment on a house you hope to make in the next 3 to 5 years, it’s worth considering adding some inflation protection, says Steve Laipply, global co-head of iShares Fixed Income ETFs — but that may come down to conversations you have with your financial professional about inflation expectations.

If you’re worried about inflation remaining elevated over the next couple of years, for instance, “you could buy a two-year TIP [ETF], and that would pretty much align with that expectation,” he says.

I bonds could also be a reasonable bet for a short-term saver who knows they won’t need the money within a year, pros say. At 4.26%, the current I bond rate beats what you’ll find from most high-yield savings accounts and short- and medium-term Treasurys.

For longer-term investors, it’s important to remember that inflation mitigation strategies are geared toward protecting short-term cash from inflation, says Cuthbert.

“Money intended for the next 10, 20, or 30 years has a different job. Its job is not just to avoid volatility. Its job is to maintain and grow purchasing power. Historically, that is where equities have done the heavy lifting,” he says.

In other words, if you’re adding TIPS or I bonds to your 401(k) because of the latest CPI print, you’re probably missing the point that stocks have done a good job over the long haul of outrunning rising prices.

“Inflation matters. But for most long-term investors, the answer is usually not to build a new inflation sleeve after the fact,” Cuthbert says. “The answer is to have a portfolio already designed around time horizon, liquidity needs, risk tolerance, and the reality that long-term purchasing power generally comes from owning productive assets.”

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