“Puttin’ holes through inflation.”
Ghostface Killah
Don’t let inflation take it all out of you
As we know, bonds can be great investment options. These are just a couple bond ideas that take it a step further and can potentially hedge against inflation, and even deflation.
Treasury Inflation-Protected Securities (TIPS)
The TIPS principal – the original price paid on the market – adjusts with inflation (it goes up) and deflation (goes down). Like other bonds, you also get paid interest twice per year. Because the principal value varies with inflation, that means the interest payments will change through the year, as well.
TIPS are used to hedge against inflation. It’s not for certain, like everything in our bittersweet, sweet life, because nothing last forever, nothing is for certain, nothing is for sure. In the midst of this uncertainty, you can still use TIPS to protect the buying power of those hard earned dollars in your account.
Investors receive higher interest or coupon payments as inflation rises. Conversely, investors will receive lower interest payments if deflation occurs. That’s an important point, because these bonds almost require inflation in order to generate true value. However, it matters how long you hold these bonds. As Investopedia notes:
“If inflation does not materialize while TIPS are held, the utility of holding TIPS decreases” & “The investor is never at risk of losing the original principal if held to maturity… If investors sell TIPS before maturity in the secondary market, they might receive less than the initial principal.”
Series I Savings Bonds (I Bonds)
Because they’re backed by the federal government, I bonds are considered a safe investment vehicle.
I bonds combine two interest rates to get their yield: one fixed by the Treasury that is set for the 30 year life of the bond; and another one based on the consumer price index (CPI), which is updated every six months. The rate at which you purchase your I bond is applied through the next 6 months after the purchase is made.
Treasury Direct’s example: If you buy an I bond on July 1, 2022, the 9.62% would be applied through January 1, 2023. Because of this cadence, interest is compounded semi-annually for I bonds.
A great benefit: even if there’s deflation, 0% is the lowest the yield can go.
I bonds have tax benefits also. You’ll receive the interest when the bond matures or you redeem it at the Treasury. Because of this, you won’t owe taxes until you’ve redeemed it. Also, you only pay federal taxes, not state or local.
Yet, another benefit: If you use the interest to pay for college, you won’t owe any taxes at all.
But there are drawbacks. There’s a $10,000 annual cap on how much you can spend on I bonds, though you can tack on another $5,000 if you use your tax return to get them. You’re also not allowed to cash out your I bonds for at least a year, and you won’t get all the interest (you’ll lose out on 3 months of it) unless you wait 5 years.
You can’t buy I bonds from your broker, and there’s no ETF or mutual fund for them. You can only buy your series I bonds at Treasury Direct.gov.
Now go out there and show inflation who’s boss.
