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Brett Arends's ROI

July 16, 2022, 3:47 p.m. EDT

What can retirees do about inflation?

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By Brett Arends

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And these TIPS bonds, as they are known…are also down.

The iShares TIPS Bond ETF /zigman2/quotes/200600110/composite TIP -1.03% is down 12%. The PIMCO 15+ Year TIPS Index ETF /zigman2/quotes/208968406/composite LTPZ -1.92% , which invests in longer-term TIPS bonds, has plunged 28% since the start of the year. If you’d predicted this huge inflation surge last fall, and loaded up on long TIPS in anticipation, you’d have done worse than someone who just kept their money in the S&P 500 /zigman2/quotes/210599714/realtime SPX -1.79% .

Which is, as my friend says, “madness.”

I’ve written about all of these assets before. They have all been tanking all year. As for TIPS: Their plunge is the reason that the bond market’s 5-year inflation forecast remains so low, even now.

Right now the U.S. bond market is still predicting inflation to collapse, and to average just 2.5% over the next five years. That forecast has fallen by a third since its peak in March, and is now lower than it was in the spring of last year—when there was basically no inflation at alll.

So the bond market still doesn’t expect inflation. Nor do the markets for gold, resource stocks, real estate trusts and the like. And nor do investors for TIPS bonds.

Make of this what you like. I have absolutely no idea what is actually going to happen to inflation, and I don’t pretend to. (I am always amazed at the way otherwise intelligent people will suddenly lapse into fortunetelling.) I’ve been reporting for months on what the bond market is forecasting. Maybe it’s right. Maybe it’s crazy.

The limited good news here is that the falling price of inflation protection this year creates an opportunity for all those who either expect inflation to continue, or who — at least — cannot afford to leave themselves exposed to it. That includes many, possibly most, retirees.

Bonds work like seesaws: When the price falls, the yield or interest rate rises. Inflation-protected Treasury bonds, or TIPS bonds, have fallen to the point where someone buying them today can guarantee that their purchasing power will beat inflation over the long haul, no matter whether it averages 2.5% a year or 9% or 16.8%. All they have to do is buy the bond and hold it until it matures. (Between now and that point the price can fluctuate up and down, as it has this year.)

Especially notable are the TIPS bonds that are not due to be redeemed for another 20 or more years. TIPS bonds that mature between 2041 through 2050 currently offer “real” yields, meaning a rate of interest on top of inflation, of 1% a year or better. The 2045 bonds yield inflation plus about 1.2%. a year, which means your wealth is guaranteed to be worth about a third more in real, purchasing power terms by then so long as you buy the bond and hold it until maturity.

(But with TIPS the floor is also the ceiling. Buy and own this bond until 2045 (for example) and at the end you will be some 30% richer: No less, but no more either. Your return is locked in.)

Pro-tip: Always own TIPS bonds in a tax-sheltered account like an IRA if you can, because otherwise you will get some annoying an unpleasant tax bills every year.

Earlier this year there was a small stampede of people buy  “I Bonds,”  a government-issued investment which is protected against inflation and similar to TIPS in many ways. TIPS have two advantages compared with I Bonds: There are no annual limits to how much you can buy, and you can hold them in a tax-sheltered account.

TIPS have one comparative downside. These bonds are freely traded, so the price can drop (or rise). Once upon a time, back in the early 2000s, they were much cheaper. They were new products back then, and Wall Street didn’t value them as highly. But we also didn’t have quantitative easing and zero interest rate policies. So, for various reasons, TIPS bonds were so cheap you could buy them with “real,” inflation-adjusted yields north of 2%.

If such happy times reappear, someone who buys a bond today with a 1% real yield will see the price fall. And may be kicking themselves for a missed opportunity.

On the other hand, if the bond market starts panicking about long-term inflation you can probably expect these bonds to go a lot higher—at which point you may be kicking yourself for not buying them now.

The longer-term the TIPS bond you buy, the higher the guaranteed inflation-adjusted yield…but the more volatile the bond’s price. A basic TIPS fund like TIP or Vanguard Inflation-Protected Securities /zigman2/quotes/204162186/realtime VAIPX -0.98% owns bonds of all maturities, and will be much less volatile.

Standard disclaimer: If I knew what was going to happen, I’d be filing this column from my yacht.

But if you are, for example, a retiree and you need to protect yourself against inflation, TIPS are a good way to do it.

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