One reason the stock market fell sharply last week was new worries about inflation. So, Morningstar and others are recommending that you buys TIPS – Treasury Inflation-Protected Securities.
Their reasoning is that because twice a year, the value of a TIPS is adjusted upward to match the rise in the Consumer Price Index (CPI) and interest is alway paid on the adjusted value or face value, whichever is higher you will always stay ahead of inflation. What could be wrong with that?
I looked at Schwab’s inventory of TIPS this morning. Yields ranged from 0.1% to 0.8%. The latter was on a TIPS maturing in 2029. If you’re happy with interest that is a fraction of a percent above inflation, well go ahead and buy some. You are protecting your money but not getting much else.It is higher than a money market in terms of interest but you can lose money in TIPS.
The bigger problem is that 90% of people will buy a mutual fund of TIPS. That is not generally a good idea. Why?
1) The mutual fund has expenses, even a no-load fund has operating expenses. When those are deducted you may be in the hole. Then deduct fees for your financial advisor or 401(k) expenses.
2) Tips are volatile, not steady in price. In 2008, the best “inflation-protected” mutual funds lost 10-20% while many other bond funds were making money. There was a sharp drop in 2013 of 12-15% and one in 2016
3) TIPS funds generally fall in price when interest rates go up like they are now. Because of an inflation scare this year you would think this year so far would be a good return. But, as of 2/14 the best funds are -2% instead.
4) Inflation protected funds lose money in many years. Look up annual returns on PRRIX, the top performing TIPS fund. 2018 -2%, 2017 4%, 2015 -2.8%, 2014 3.4%, 2013 -9%. Uh, no thanks..After fees, only when inflation is rapidly rising do you really make money.
5) TIPS funds can sell off in stock market panics. See 2008.
Bottom line – TIPS and especially inflation-protected funds are a bad investment most of the time. Buy individual inflation protect securities if all you want is to keep up inflation. But, you should generally avoid the mutual fund or ETF varieties. I have other, better ideas for lower risk income.