Beating Inflation Safely: Why TIPS Offer One of the Best Opportunities in Years

Luckily, investors have an opportunity to beat inflation by some of the best margins in years.

Real yields for Treasury Inflation-Protected Securities, or TIPS, have steadily increased, offering one of the juiciest ways to beat inflation in decades safely. With these high yields, investors can lock in their future spending needs without taking on significant risks.

$9.82. That’s the current price for an 18-pack of eggs at my local Walmart. While the price of eggs may be extreme, it highlights the continued pressure consumers have faced in recent weeks.

We all know the story. Inflation spiked in 2022 and 2023 as pandemic-era stimulus met headfirst with a snapback in demand. After peaking at 9.1% in June 2022, the invisible hand of rising prices has spent much of the last two years shrinking. The problem is that it hasn’t continued to shrink.

With the latest CPI report — released for February figures — inflation has risen by 2.8% year-over-year. The February reading was the lowest pace of price increases in the last four months. However, the report highlights the stickiness of the CPI. Since the Fed’s first rate cut last September, inflation has moved sideways — steadily increasing along with expectations of a bullish economy and demand.

This chart from news agency Reuters highlights the sideways and slightly upward-sloping trend of the CPI and other measures of inflation.

Source: Reuters

Compounding the issue

All of this is problematic when it comes to fighting higher inflation and the Federal Reserve’s path of rate changes.

With inflation rising, investors would do well to try and fight the issue. With stocks starting to falter, a safe avenue for this fight is quickly becoming a top-notch investment choice. We’re talking about Treasury Inflation-Protected Securities, or TIPS.

TIPS are like a funky bond that offers a unique way to profit against changes to inflation. These securities come with an initial coupon but then change their payouts by resetting their principal values based on changes to the CPI. A $1,000 TIPS with a 1% coupon under a flat CPI would pay $10 in interest. If the CPI jumps by 2%, the TIPS adjusts its principal upward by 2% to reach $1020 and the 1% in coupon against that would be $10.20 in interest. In periods of deflation, TIPs can adjust their principal lower. Complicating things further, TIPS trade on the secondary market

The key to TIPS and why they make for a great play in the current environment is something called the real yield. The real yield is the return after inflation or over inflation. A nominal bond — like a 10-year Treasury bond or 5-year note issued by Walmart — pays a static coupon. The real yield for this bond is 4% or 5% minus the rate of inflation. It’s the interest you’re receiving after accounting for inflation.

However, because TIPS adjusts its principal to combat inflation, investors in the bond will generally beat the CPI by a certain amount. And right now, real yields on TIPS haven’t been this good in years.

Normally, TIPS provide a real yield of around 1% to 1.5%. So, you are “beating” inflation by this much. That’s not a bad return for a safe part of your portfolio.

However, today, a 10-year TIPS bond has a real yield of just over 2%. Looking at the 30-year TIPS, the number is closer to 2.4%. After hitting lows at the beginning of March, both real yields have been steadily climbing.

So, what does that mean? By buying the TIPS, you are virtually guaranteed to generate a return that beats inflation by 2% or more for the next decade, or even potentially three decades. That’s a huge win for retirees and investors looking at liability planning.

With real yields so high, many investors can take equity risk off the table and lock in inflation-protected income for their entire retirement or a major portion of their expenses. We often talk about the 4% withdrawal rule. Here’s a way to get that 4% with inflation protection. It’s a gift that doesn’t normally happen in such abundance.

With real yields running at historically advantageous rates, TIPS can be seen as a top draw for fighting inflation, the Fed’s quandary of rates, and any additional inflation created by presidential policies.

There are some quirks about TIPS and making this work.

For one thing, investors looking to make an income plan using TIPs need to purchase a so-called TIPS ladder. You’re buying a bond to cover a set amount of income each year of retirement. However, the Treasury hasn’t issued TIPS that mature in the five years from 2035 to 2039. Investors will have to adjust or overweight earlier or later bonds to cover those years.

Secondly, this only works if you buy and hold the bond till maturity. Selling beforehand doesn’t guarantee that you’ll beat or even match inflation. You could lose money this way. Investors also need to be wary of the bond’s “phantom tax,” which requires them to pay taxes on the principal inflation adjustments in the year they occur even though they won’t receive that adjustment until the bond matures.

If you decide that TIPS make sense for you — and given the high real yields, they should — adding them is pretty simple. Any good brokerage firm should allow purchases, in both taxable and IRA accounts. You can also buy them directly from the Treasury for a $100 minimum.

Now, there are a lot of TIPS ETFs out there. They can be used to provide inflation protection, but not in the same way. TIPS ETFs constantly roll over their holdings to keep their mandates and, as such, are at the whims of market conditions, investor selling, and changes to interest rates. Where they win is during periods of sudden spikes of inflation. You won’t get the same constant, steady, inflation-protected cash flows as buying and holding an individual TIPS.

These funds were selected based on their exposure to Treasury Inflation-Protected Securities (TIPS). They are sorted by their YTD total return, which ranges from 2.3% to 3.5%. They have expenses between 0.03% and 0.20% and assets under management between $727M and $52B. They are currently yielding between 2.4% and 4%.

All in all, TIPS offers a heck of a deal with real yields now close to or above 2%. Historically, this has been a very lucrative time to purchase these bonds. For many investors, the ability to lock inflation-protected income today for spending tomorrow is a godsend, reducing market and even sequence of withdrawal risks.

It’s not often the market hands investors a gift. Today, that gift is in the ability to lock inflation-protected income for decades. TIPS have some of the best real yields in a long time. This makes adding future income to a portfolio easy and removes many risks off the table for retirees.