Here’s a rare breath of fresh air for retirees and older investors: Inflation-protected Treasury bonds are paying a positive rate of interest again.
Well, some of them. A few. And it’s not exactly much. But at least it is positive, which is a change.
It tells you something about the plight facing older investors that this development is noteworthy.
Thirty-year TIPS bonds are promising to pay 0.13 percentage points—no, really—a year over the rate of inflation between now and 2052, the U.S. Treasury confirms. That may sound like a pittance. But it’s a heck of a lot better than a few months ago, when the same bonds were promising to pay 0.5 percentage points a year less than inflation.
Read: Retirees, pay attention — inflation is on the rise
And it’s a lot better than shorter dated TIPS, which are still promising to lower your purchasing power over time. The 5-year TIPS bond will pay you 1 percentage point less than inflation between now and 2026.
In other words, if you buy a 30-Year TIPS bond today and hold it until it matures, in 2052, it is a guaranteed, fail-safe protection against inflation over that time — no matter what inflation comes along. (Important caveat: If possible, hold TIPS bonds in a tax-deferred account like an IRA. Otherwise the annual tax complications can be unpleasant and costly.)
TIPS bonds are, in theory, the perfect investment for retirees, older investors, and anyone who doesn’t want risk in their portfolio. They protect your principal and your standard of living. The rate of return is tied to the official inflation rate, so when prices surge, as they have recently, so will your effective rate of interest.
But the reality isn’t quite so simple. TIPS bonds trade in the market, so prices can go up, making them very expensive to own, or down, making them very cheap to own. Bonds work like seesaws: When the price rises, the yield or interest rate falls.
Read: Inflation is making some seniors choose between food and medications — what you can do
That’s what’s been happening for years. When TIPS bonds were first launched in the late 1990s, they sometimes offered yields, or interest rates, of 3 full percentage points above the rate of inflation. For much of the 2000s—the Zeroes I used to call them, until I realized decades could get even worse—they often paid 2 full percentage points above inflation. But in recent years they have rocketed in price, as investors seek safety of principal and protection against inflation. And at this point they are, or look, very expensive.
As my colleagues have pointed out, there is a less-known U.S. alternative known as I Bonds that has been a bit less expensive than TIPS. But these I Bonds come with certain caveats—you can only buy $10,000 worth a year, for example.
The recent “good” news on TIPS is only good if you don’t already own these bonds. That’s because the reason the yields have risen is because the price has fallen. The PIMCO 15+ YEAR TIPS ETF
LTPZ,
for example, has fallen about 10% so far this year. The broader Vanguard Inflation-Protected Securities ETF,
VAIPX,
is off about 3%. But those with plenty of cash or short-term paper in their accounts have the option of buying more TIPS at today’s lower prices.
Should they?
TIPS are cheaper than they were, but they are no steal. Historically, going back at least to the 1920s, someone buying standard 10 Year U.S. Treasury bonds, for example, has on average ended up earning about 1.6% a year on top of inflation. That’s the average real return earned on these bonds over the course of a decade (and even longer, actually). So long-term bonds paying effectively a real yield of 0% are hardly a bargain. And you’re only getting that 0% yield if you buy the long-term TIPS, and those, as investors have just learned, are volatile.
But.
Older investors have limited options available to them. If you sit holding all your money in cash waiting for TIPS to get really cheap, you could wait indefinitely. And meanwhile your money is losing ground against inflation.
And those historic numbers on regular bonds are only averages. Like all averages, they hide as much as they reveal. When I ran numbers going back to the 1920s, I found that investors who bought regular 10-year U.S. Treasury bonds — in other words the traditional bonds, with no inflation protection — had ended up losing purchasing power over the next decade about one time in three. In other words, historically you’ve had a 33% chance of losing money on 10-year U.S. Treasury bonds in real, purchasing power terms. By that measure, a bond that cannot lose purchasing power has a lot of appeal, even if it seems to have limited upside.
The best appeal of TIPS right now is as insurance against a big, sustained, 1970s-style inflation.
Contrary to conventional “wisdom,” there is currently no convincing evidence that current levels of inflation are here to stay. Inflation is high, but we don’t yet know if it is going to be long. And hardly any commentators on this topic can be trusted, because everyone is grinding a political ax. The bond market, for what it is worth, is not currently panicking about sustained inflation.
But we insure against things that might happen, not against what is guaranteed. So holding some TIPS makes sense, even if they are not a bargain.
Jonathan Ruffer, the chairman of London investment house Ruffer & Co., wrote recently that inflation-protected bonds “trade enormously expensively, but they are still good value.” He compared them, whimsically, to an “overlooked Canaletto” in an art gallery: “priced much too highly for what its owner thinks it is, but still a bargain for what it actually is.” That was nearly two months ago. Since then they are less expensive, and better value.
This post was originally published on Market Watch
