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With the Federal Reserve looking to start raising interest rates as soon as next month, investors may be looking for ways to protect their portfolio. While many may look at moving assets into more conservative assets like short term bonds and Treasuries, some will look to Treasury Inflation Protected Securities (TIPS). And that could be a mistake. TIPS work almost just like traditional bonds except that they are indexed to the current rate of inflation. For example, if a $1,000 bond is purchased at par value and the inflation rate is measured at 2%, at the end of the year the principal balance of that bond will be adjusted to $1,020. The higher the inflation rate, the higher the principal balance adjustment. But that’s where the protection ends. Outside of the inflation adjustment, TIPS behave just like any other bond. Shorter term TIPS are generally very conservative investments while longer term TIPS carry a greater degree of volatility. As is the case with any investment that comes with risk, the total value of the investment can potentially lose money over time. All 14 non-leveraged TIPS ETFs that have been around for the last three years have lost money during that time frame. The largest – the iShares TIPS Bond ETF (NYSEARCA: TIP ) – has lost 5.9% during that period. The second largest – the Vanguard Short-Term Inflation-Protected Securities ETF (NASDAQ: VTIP ) – has dropped a more modest 2.4%. As would be expected during a period where bond funds have dropped in value, those on the shorter end of the yield curve have fared the best. Those funds targeting a duration in the 3 year or under range have dropped around 3%. Funds with a slightly longer duration have dropped more with the FlexShares iBoxx 5-Year Target Duration TIPS Index ETF (NYSEARCA: TDTF ) down nearly 5%. ETFs with a long term duration or international TIPS exposure have fared the worst of the bunch. The PIMCO 15+ Year U.S. TIPS Index ETF (NYSEARCA: LTPZ ) has fallen more than 10% over the past three years while the iShares International Inflation-Linked Bond ETF (NYSEARCA: ITIP ) has lost over 16%. All of this is to say that TIPS funds and ETFs provide little protection from the effects of interest rate movements. In economic environments like the current one where inflation still remains below the Federal Reserve’s 2% target, TIPS products can underperform. The Vanguard Total Bond Market ETF (NYSEARCA: BND ) has gained almost 5% over the past three years. Inflation risk isn’t the same as interest rate risk. It’s important that investors know the difference. Scalper1 News
Scalper1 News