Inflation protected securities
Question: I am enthusiastic about your recommendation to make TIPs a core investment. I appreciate this advice along with many other recommendations of yours during the years. All of my TIPs are in an IRA. Consequently, the TIPs are held in a mutual fund. Is your recommendation for TIPs as strong even when they are held in a mutual fund? Thank you. John, Brookfield, WI
Answer: Yes, I think owning Treasury Inflation Protected Securities or TIPS in a bond fund works as a hedge against inflation. Professor Zvi Bodie of Boston University is the leading proponent of the TIPS as a core investment for retirement savings. (I'm also a huge fan of his and I've learned a lot interviewing him over the years.) He notes that owning the bonds directly gives you greater control over the timing of when you receive your inflation-hedged cash. You're also agnostic to fluctuations in market value if you own the actual bonds and hold them to maturity. (When a bond matures you get your underlying investment back. So, if you bought a $1,000 bond with a 10 year maturity you'll get your $1,000 back in 10 years.) However, the way the U.S. Treasury rules are currently written you can't buy TIPS directly from the government for your IRA or comparable retirement savings account. You must use a broker or middleman. It's still a worthwhile cost of ownership since the commissions attached to buying U.S. Treasuries are typically very low.
Nevertheless, for many of us buying TIPS through a mutual fund is convenient. Many employer-sponsored retirement savings plans only give us the option of a mutual fund that invests in inflation-protected securities. The portfolio will be volatile reflecting changes in the market and the outlook for inflation. Since the mutual fund doesn't have a specific maturity date you're never quite sure what the payoff on your investment will be in the future. But the mutual fund TIPS investment offers a hedge against inflation.
By the way, the latest issue of the Journal of Financial Planning has an illuminating interview with Bodie on TIPS, the returns to equities, his thoughts on run-of-the-mill investment advice, and other topics. You can read it here.