MAKING SEN$E -- May 9, 2011 at 11:53 AM ET
Making Sen$e: My Least-Favorite Investment Vehicle (Except For All the Other Ones)
Paul Solman answers questions from NewsHour viewers and readers on business and economic news most days on his Making Sen$e page. Here's Monday's query:
Name: Will G. Knox
Question: Safety of TIPs?
Paul Solman: The shortest question ever received on the Business Desk demands a rather more discursive answer. As longtime readers of this page may recall, my own family's retirement fund is heavily invested in Treasury Inflation-Protected securities. At the moment, more than 50 percent of it. TIPs are U.S. Treasury bonds -- loans to the U.S. government -- whose return is made up of two interest rates:
- A rate set by the market, often interpreted as the economy's "real" risk-free rate of interest, and
- The inflation rate, as measured by the Consumer Price Index (CPI).
Put the two together and you've got the TIPs rate -- a modest rate on the order of 3 - 5 percent in recent years, depending to a large extent on your bond's "maturity" (how long til the bond is paid back). But its great virtue is that, as the name says, it's "inflation-protected." There are numerous write-ups of TIPs on the Internet. This recent one is more comprehensive than most.
TIPS, or Treasury inflation-protected securities.
If you buy the TIPs directly from the government, most conveniently at www.Treasurydirect.gov, you will have locked in an inflation-protected rate of return until the bond matures. My friend and personal investment adviser, Boston University finance professor Zvi Bodie, is lead author of the most popular investments textbook, known informally as "Bodie Cane Marcus." He has also written a book whose name suggests his general orientation: "Worry-Free Investing."
Intent on being worry-free himself, Bodie holds a portfolio of "laddered" TIPs that mature in different years. His aim has long been to preserve his family's standard of living in retirement and with TIPs, he will get a predictable, if modest, return that's not vulnerable to a spike in inflation.
As for me, I invest in a TIPs mutual fund because that's all my retirement plans ever offered. It has the disadvantage of fluctuating in price daily, so I haven't locked in a future return. On the other hand, I've slept a lot better at night than I would have, had my retirement been dependent on the stock market or other more volatile asset classes.
You ask about the safety of TIPs. And indeed there have been warnings of late that the "real" rate of interest is historically low and has only one way to go: up. In the same way that bond prices go up when the interest rate rises, a rise in the real interest rate would reduce the value of TIPs.
But let me throw the laconic question back to you: "Safety of TIPs"? Compared to what? Stocks? The S&P 500 index is at 1339 as I write. It was at 1500 eleven years ago. As I've pointed out recently, Japan's Nikkei hit 39,000 in 1989. Twenty-two years later, it's lucky to break 10,000. If the same thing happened to the U.S. stock market, which peaked in 2006, in the year 2028 we'd have a Dow-Jones of 3400.
Gold? It was at a lowly $280 an ounce in the spring of 2000 and has risen six-fold since, for an annualized return of 16.5 percent. But I was around in January of 1980, when the precious metal hit $850 an ounce. It took a mere 28 years to return to that price. Gold's annualized return from 1980 to the present: 1.85 percent a year.
Bottom line: I can't guarantee the safety of TIPs. But I just don't know what's safer.