Friday, February 26, 2010

TIPS: Danger Ahead

Most of us are aware that the Federal Reserve has said that interest rates are going to rise.  Many Boomers have moved their investments into bonds as they aged or as a knee-jerk reaction to the market decline.  But when so many people head in one direction, for whatever reason, problems usually develop.  And that is what we have here.

Some folks moved into bonds and some, thinking that inflation was the real long-term worry, bought TIPS.  Turns out, both kinds of investors might be wrong.

Treasury Inflation Protected Securities are not the same as an investment that protects you from rising interest rates. While it is easy to see how investors can be confused by this, it will be a very costly mistake if you made it. In a follow-up to our warning about the potential, even probable bubble in the bond market posted a couple of days ago, investors who sought refugee in this type of security will also find trouble on the horizon.

A good deal of you moved into bonds without really knowing what you were getting into. A portion of you went with the safest bond available, the Treasury bonds. These are purchased at face value and pay a coupon (or interest rate payment) based upon the agreed upon rate at the time of purchase. Inflation can take its toll on those “yields”, as the interest paid to you is often referred to. Real yield however is the coupon payment less inflation. If inflation is low, as it has been over the last year or so, the yield on your bond will be relatively predictable and even quite profitable.

To read more on this topic about TIPS, click here.

Paul Petillo is the Managing Editor of and a fellow Boomer.

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