“TIP”S to Gauge Inflation Risk

by brendon on May 2, 2011

How can fee-based investment advisors, financial planners and Kansas City investors like you “gauge” inflation risk when added media coverage increases fear about it? Coverage about the lowering value of the US dollar and subsequent rise in the cost of oil and consumables that are dependent upon imports is an example of one such story?

The answer…….T.I.P.S.

Are you worried about inflation? Most consumers will say yes. Is it important? Of course! What can you do to control it? Nothing. But you can control your response to it by understanding a simple concept and owning a properly diversified and allocated investment portfolio.

T.I.P.S. are Treasury inflation-protected securities; properly structured investment portfolios will devote a portion of $$ to this segment. Do you have T.I.P.S. in your portfolio? Do you know what your expected annualized rate of return is? Do you know your worst case scenario for a possible loss in your account?

My investment analysis will tell you.

The tip for “gauging” inflation risk is this: know the gap between yields on plain-vanilla Treasury bonds and T.I.P.S. of the same maturity. T.I.P.S. are regularly adjusted for inflation, so this gap in yields, called the break-even inflation rate, shows how much future interest traders are willing to give up for inflation protection.

Based on the break-even inflation rate and this article, “Inflation? Numbers Show Faith in the Fed” (WSJ, April 29, 2011), “long-term inflation expectation gauges, from consumers and from the bond market, remain subdued and are little changed from a year ago. They point to inflation that isn’t far above the average of the past decade, when inflation was historically low.”

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