Content courtesy of Dimensional Fund Advisors.
Rising inflation may leave investors wondering whether they should keep fixed income out of their portfolios, but history shows Treasury Inflation-Protected Securities (TIPS) can be a useful tool to hedge against inflation.(Footnote 1)
TIPS vs. Inflation
TIPS outperformed inflation (Footnote 2) in 72% of the rolling, overlapping 12-month periods from 2001 to 2021 (Footnote 3) (see Exhibit 1). (Footnote 4) Put another way, TIPS helped investors preserve their purchasing power in nearly three out of four of the 252 rolling one-year periods over this 20-year span, according to Dimensional research.
EXHIBIT 1
Here’s a TIP
In USD. Sources: Bloomberg, Federal Reserve Bank of St. Louis Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
However, like all bonds, TIPS can be affected by changes in interest rates. When rates rise, the prices of existing bonds fall as new bonds issued with higher rates become more attractive. That means the total return of an inflation-protected security can be higher or lower than the annual inflation adjustment.
Still, for investors determined to protect their purchasing power as inflation rises, TIPS can be an effective option.
TIPS Can Help Investors Hedge Inflation
Treasury Inflation-Protected Securities can be an effective tool for investors seeking to protect their purchasing power as inflation rises.
FOOTNOTES
The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, investors are paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; that means interest payments, like the principal, rise with inflation and fall with deflation.
Based on non-seasonally adjusted percentage change in Consumer Price Index for All Urban Consumers (CPI-U). Source: US Bureau of Labor Statistics.
Rolling, overlapping returns measure the return for each 12-month period (January to December, February to January, March to February, etc.) between the start and end dates.
Bloomberg US TIPS Index, January 2001 through December 2021. Bloomberg data provided by Bloomberg.
DISCLOSURES
Risks include loss of principal and fluctuating value. Fixed income securities are subject to increased loss of principal during periods of rising interest rates, and they are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. Inflation-protected securities may react differently from other debt securities to changes in interest rates.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.