Income "TIPs" from Retirement Watch

11/10/2020 5:00 am EST

Focus: BONDS

Robert Carlson

Editor, Retirement Watch

We’re going to be in a 0% interest rate world for a while with the potential for slow growth. Investors must learn how to invest in that environment, cautions Bob Carlson, editor of Retirement Watch.

One action is to find a substitute for nominal bonds. If you’ve followed any of the financial media, you know that bonds don’t provide their historic diversifying benefits when interest rates are zero.

There’s little room for interest rates to fall, so bonds won’t rise when stocks decline. That’s why we moved a portion of our portfolios into Treasury Inflation-Protected Securities — know as TIPS — through the exchange-traded fund, SPDR Portfolio TIPS (SPIP).

TIPS provide inflation protection, and inflation is the greatest risk to nominal bonds for at least the next few years. Inflation doesn’t change the interest paid by a TIPS bond, but the principal value will increase each year with changes in the Consumer Price Index.

That annual increase will be taxable, though you don’t receive cash. That’s why it’s best to hold TIPS in a tax-deferred or tax-free account.

TIPS also become more popular and rise in value as inflation or inflationary expectations increase. TIPS are much better than traditional nominal bonds in this environment. Its total return for the year to date is 9.53%. The yield was 1.91%.

By comparison, the long-term government bond iShares 20+ Year Treasury Bond ETF (TLT) is down 1.86% over the last four weeks and 3.92% over three months. I expect TIPS to have higher returns and provide better diversification than nominal bonds the next few years.

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