Ibonds vs TIPS - What's the best inflation protection?
Inflation is the number one enemy for retirees. And as investors seek protection from inflation with their savings they are usually led to one of two options for how to hedge against inflation, treasury inflation protected securities, also known as TIPS, or I Bonds.
We find that a lot of investors see these 2 options as very similar types of investments, but that is really not the case.
IBonds vs TIPS:
I bonds, or series I savings bonds, are a very simple and straightforward investment. They provide an interest rate that adjusts to inflation, and they can never decline in value. We think I Bonds are great and are one of the best protections against inflation for your savings.
The major drawbacks to IBonds is that each individual is limited to $10,000 per year in purchases, and you can not purchase these in retirement accounts like 401(k)s, or IRAs.
This makes it hard to have IBonds be a significant portion of your retirement portfolio.
TIPS vs Ibonds:
TIPS on the other hand are very complex, and function very differently than many investors expect.
First, unlike I Bonds, TIPS do not protect you from all inflation, only unexpected inflation. When you buy a TIP you pay a premium compared to ordinary treasury bonds. This means that for a TIP to ultimately be a good investment, inflation has to be above a certain breakeven rate that is built into the TIP and already priced by the market. You must be sure you understand what that breakeven is, and the amount of inflation that is already priced into the bond at the time of purchase.
Also, TIPS can carry substantial interest rate risk. While you are guarded against unexpected rises in inflation, a general rise in interest rates will still negatively impact the value of your investment. We saw this in the first 9 months of 2022, which saw general TIPS funds decline 13% or more, despite having the highest inflation we’ve seen in 40 years.
Ultimately, we find that TIPS, and long term TIPS in particular, are not a good fit for many of our clients. While I series bonds are superior, it is difficult to amass enough to have a sizeable role in your asset allocation.
We typically find that there are other, better ways for most investors to protect themselves from inflation. Usually through utilizing shorter maturity bonds, and investing more in broadly diversified investments.
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