How to make inflation-protected bonds work in your portfolio as interest rates rise

Advisors

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It’s been a tough year for bonds, including Treasury inflation-protected securities, or TIPS, an inflation-linked asset. Despite recent losses, TIPS offer portfolio diversification amid market uncertainty, experts say.

Backed and issued by the U.S. government, investors can buy TIPS in five-, 10- or 30-year terms, with twice-annual payments based on the assets’ value, which adjusts every six months with inflation.

However, bond values and market interest rates move in opposite directions, making TIPS values drop as the Federal Reserve has hiked rates.  

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As of Oct. 10, the iShares TIPS Bond ETF is down more than 13% year to date. However, TIPS have outperformed the S&P 500 Index, which is down nearly 24% over the same period.  

“It’s been a perfect asset in this environment,” said certified financial planner Anthony Watson, founder and president of Thrive Retirement Specialists in Dearborn, Michigan.

TIPS — particularly TIPS funds with shorter average maturities — have offered a cushion amid double-digit losses for the stock and bond markets, he said.

As interest rates rise, you want TIPS to mature and get reinvested faster, taking advantage of higher yields more quickly, he said. 

Generally, Watson allocates 20% of a client’s fixed income portfolio to a TIPS fund, such as the Vanguard short-term inflation-protected securities index fund ETF, which invests in assets with average maturities of 2.6 years.

JPMorgan Chase CEO Jamie Dimon on Monday said the U.S. will likely fall into a recession over the next “six to nine months,” and predicted the S&P 500 could decline by another 20%, depending on the Federal Reserve’s future plans.

It’s been a perfect asset in this environment.
Anthony Watson
Founder and president of Thrive Retirement Specialists

Nicholas Bunio, a CFP with Retirement Wealth Advisors in Berwyn, Pennsylvania, also uses TIPS allocations for diversification, opting for funds over individual assets for “ease and convenience.”

However, if someone can’t stomach losses from TIPS, there’s always the option to buy individual TIPS and hold them to maturity, he said.

TIPS investors focus on ‘capital preservation’

David Enna, founder of Tipswatch.com, a website that tracks inflation-protected assets, said “capital preservation” is one of the prime motivations for TIPS investors, especially those approaching retirement. 

“They’re a lot less risky right now than they were,” Enna said. “And they’re certainly less risky than the stock market right now.”

“I think it’s good to have a mix of types of fixed income,” Enna added, who personally owns both short-term TIPS funds and individual TIPS.

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