With many developed countries throwing money at credit-starved economies, investors worry about possible inflationary consequences and TIPS, Treasury Inflation-Protected Securities, may just be the right exchange traded fund (ETF) for them.

TIPS are government-issued treasury bond indexed to the Consumer Price Index (CPI), writes Jonathan Bernstein for ETFzone. This investing instrument will have secure returns, will be guaranteed by the government and the returns will not be reduced by inflation.

As inflation increases, the principal and interest of TIPS bonds increases. As inflation decreases, the principal and interest will decrease by a corresponding amount to the CPI. The TIPS bond is paid either the original principal or adjusted principal upon maturity.

Instead of having to resort to buying separate TIPS bonds, an assortment of TIPS bonds can be bought with a single transaction as a TIPS ETF.

In September and October of this year, the prices of treasury bond and TIPS ETFs diverged sharply. Inflation is classically described as an increase in the overall money supply, but it also refers to the rate of increase in the price of goods and services. In September and October, the money supply shrank, home prices and commodity prices tanked and deflation threatened. A sharp change in inflation expectations led to the divergence, and it’s a risk to be aware of.

• iShares Lehman TIPS Bond (TIP): down 6.6% year-to-date

• SPDR Barclays Capital TIPS (IPE): down 6.5% year-to-date

• SPDR DB Intl Govt Infl-Protected Bond (WIP): down 29.2% since March 19 inception

Tags: IPE, TIP, TIPs, WIP

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