How to Use ETFs to Protect from Inflation

Some investors believe that inflation will be the next phenomenon to overcome our economy.  So how can one utilize exchange traded funds (ETFs) if this does happen?

The answer is fairly simple and lies in Treasury Inflation Protected Securities, or TIPS.  These investment tools are fairly simple to understand, they are redeemable at par with a fixed coupon rate and maturity date, they are traditionally used to hedge against inflation and the principal value is adjusted up or down depending on the inflation rate.  To add icing to the cake, many believe that even if the tables are turned and deflation takes its course, TIPS will still outperform many other asset classes, states Robert Huebscher of Advisor Perspectives.

There are downsides that one should be aware of with TIPS, as well.  They are a bit riskier than most think.  When they are held to maturity, they yield their real interest rate adjusted for inflation, whereas price movements over the life of the bond can be somewhat uncertain.  This could potentially skew the performance of these fixed income tools, because history dictates that interest rates are unstable.

If one wants to add TIPS to their portfolio, take a look at the iShares Barclays TIPS Bond (TIP), which yields 5.03% and is up nearly 3% year to date.

Kevin Grewal contributed to this article.