Treasury TIPS: A Looming Disaster for Small Investors

Treasury TIPS: A Looming Disaster for Small InvestorsDuring the last few years, many small investors hoping to add some insurance to their portfolios invested in Treasury inflation-protected securities, otherwise known as TIPS. As the Treasury Department wanted us to know, TIPS "provide protection against inflation."

So now that inflation is again on the horizon, those investors should be sitting pretty, right? Wrong. It turns out TIPS are a horrible investment when the economy is facing higher inflation.

TIPS, you see, protect investors against a rise in the core inflation rate as measured by the consumer price index. But another, more important, phenomenon occurs when inflation hits: Interest rates go up. And when rates rise, bond prices go down. So your TIPS are protected against a rise in the CPI -- which, by the way, seems bizarrely to be moving down even as gas and food prices soar -- but as the markets react to this problem, rates are going up.

This was brought home by an excellent article in the Financial Times by Jeremy Siegel, a professor at the University of Pennsylvania's Wharton School of Business. "As economic growth recovers and real rates rise, the price of TIPS will fall, leaving TIPS investors with large losses in the face of accelerating inflation," Siegel wrote.

So much for inflation protection.

Where to Move Your TIPS Money

"There's going to be a heap of pain out there for people who bought TIPS thinking, 'I have got to protect myself against inflation," says Marilyn Cohen, CEO of Envision Capital and the author of a forthcoming book called Surviving the Bond Bear Market: Bondland's Nuclear Winter. "They will get walloped by higher interest rates and lower bond prices."

As the title of her book suggests, Cohen believes a bond bear market started last October, just before the Federal Reserve announced it was going to buy $600 billion in Treasury bonds in an effort to get interest rates to go even lower. "Bond investors around the world said, 'Oh-oh, they're going to be printing more money, and this is not going to work,' " Cohen says.
So, what should an investor with a portfolio full of long-term TIPS do now?

Siegel obviously prefers investing in stocks, referring to the long-term return of equities, which he says historically have averaged 6% to 7%. That's true, as long as you don't count the last 10 years, when they've returned very little.

Cohen says she remains a bond fan but would switch to intermediate or short-term bonds -- not bond funds.

How do you replace your safe Treasurys with something equally secure? Stick with names you know, she says: bonds from established corporate entities like Johnson & Johnson (JNJ) or even high-yield debt from the likes of Wynn Resorts (WYNN) in Las Vegas.

"Stay in front of the yield curve, which means seven years or shorter," Cohen says. "Sacrifice a little bit of yield today for the flexibility of being able to buy lots of something at higher yields down the road."

But wherever you move your funds, it's vital to recognize this: Bonds, especially government bonds, are no longer the great safe investment they have been for the past 30 years.

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July 28 2011 at 5:46 AM Report abuse rate up rate down Reply

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May 29 2011 at 1:33 AM Report abuse rate up rate down Reply

Hmm, the people who blog (and comment) about the market don't seem to understand how it works. People who invest in TIPS aren't looking to trade in bonds. They are the ones who want to hold to maturity - and US Treasury instruments are still considered one of the safest investments in the world, no matter what this writer claims. The market says they are safe - by investing in them. The fluctuations in bond price affect only bond traders, not people who hold to maturity, and TIPS investors are probably the least likely of any class or group to be trading in bonds.

February 06 2011 at 12:33 PM Report abuse rate up rate down Reply
2 replies to bansijeff's comment

I have seen a few articles like this now. I am new to TIPS and reading something like this is awfully confusing. I still do not understand how "the price of TIPS will fall". This article did not have an example explaining that particular statement. I suppose that would have been too helpful.

September 10 2011 at 8:04 PM Report abuse rate up rate down Reply

If 30 year mortgage intrest rates go up the intrest on the National Debt will go up by the same percentage and the USA will go bankrupt sooner rather than later. This is why we will go into deflation not inflation. ALSO--There is no product demand in the USA. Inflation is driven by supply and demand. THERE IS NO DEMAND FOR PRODUCTS IN THE USA.

February 05 2011 at 11:32 AM Report abuse +2 rate up rate down Reply
1 reply to ultraz2's comment

Interesting article. I've noticed that my TIPS have been taking a licking lately. They did really well when there was absolutely no possible sign of inflation and now with growth and possible inflation they're tanking. It's that buy the rumor, sell the news.

February 05 2011 at 10:06 AM Report abuse rate up rate down Reply


February 05 2011 at 9:30 AM Report abuse -1 rate up rate down Reply

If the past ten years has taught me anything about capitalism, it is that the small investor will usually lose big time. Any good news in the "sock" market and business in general refers specifically to larger business-community investors and this eventuality acts as a catalyst for small investors to be suckered in in their mistaken belief that they are included in whatever gains evolve. Forget it! Save your money and heartache. Us smallfry need to find safer ways, if there are any.

February 05 2011 at 9:21 AM Report abuse +4 rate up rate down Reply
1 reply to rayrombo's comment


February 05 2011 at 9:31 AM Report abuse rate up rate down Reply

These days we have all of the 'so called' experts. We have doctors for every ailment. We have financial advisors for every investment. What I have lived and learned is that you have to be your own doctor and your own financial advisor. There are no experts. There are only people with degrees. Some of these people need to go back to the college they received their diplomas from and ask for a refund for tuition. There are so many idiots out there who haven't got a clue as to what they are doing.

February 05 2011 at 7:51 AM Report abuse +2 rate up rate down Reply

TIPS? I gotta tip for ya: Plant your corn EARLY!!

February 05 2011 at 1:02 AM Report abuse +8 rate up rate down Reply

An incomplete, and therefore misleading, article. Whether you should continue to hold TIPS in the face of rising inflation depends on why you've included these bonds in your portfolio in the first place. If you're looking for capital gains due to a rise in the price of the underlying bonds then this article is relevant. If, on the other hand, you're using the bond portion of your portfolio to generate income--which is why most people of my experience hold bonds to begin with--you'll do just fine when inflation appears. As inflation rises, so will the dividends generated by your TIPS, which is the reason that the product was created in the first place. The only way you lose money on TIPS bonds in a rising inflation environment is if you have to cash them in before maturity. This defeats the assigned purpose of TIPS--you should have other assets in your portfolio designated to liquidate instead.

February 05 2011 at 12:24 AM Report abuse +5 rate up rate down Reply