Strategic Allocation of TIPs for Long-Term Financial Growth
Don’t want inflation to erode your savings?
Inflation is the silent killer of long-term wealth growth. If your money is sitting in savings accounts earning next to nothing, inflation will reduce your purchasing power.
The issue is…
The average person might not know that 4.4% of Americans saved their income in 2024. You also might not be aware of how inflation has been creeping up. This means that your money is not going as far as it used to, even if it looks like you’re saving.
If you don’t hedge your savings against inflation, all the years of effort you put into saving and investing could go to waste.
Treasury Inflation-Protected Securities (TIPs) could help you hedge against inflation.
In this guide, we’ll take you through the exact steps that you can take to strategically allocate TIPs in your portfolio for long-term wealth growth that keeps pace with (or even outperforms) inflation.
Ready to start building a bulletproof retirement portfolio?
Contents
You’ll learn:
- Why Smart Investors Are Loading Up On TIPs
- Understanding The TIPs Market Explosion
- How To Allocate TIPs For Maximum Protection
- Strategic TIPs Integration Methods
Why Smart Investors Are Loading Up On TIPs
Treasury Inflation-Protected Securities are different from typical bonds in one critical aspect…
TIPs adjust with inflation automatically.
If you buy a standard bond, you lock in a fixed return. But what happens if inflation spikes from 2% to 4%? Your real return gets obliterated. TIPs address this issue by increasing the principal value as per the Consumer Price Index.
Let’s check out how powerful TIPs protection can be…
Imagine if you had invested $1,000 in a 5-year TIPs bond with a coupon rate of 0.125% in October 2020. By the time it matures in October 2025, that initial investment’s inflation-adjusted value has increased to over $1,200.
That’s a more than 20% increase just from the power of inflation adjustment alone.
Inflation protection working in your favor instead of against you.
Market Numbers Don’t Lie
The TIPs market has been exploding in the recent past. We are talking about a $2 trillion market that has been growing every single year.
Treasury auction sizes have been through the roof, consistently breaking records in 2021 and beyond. There’s a reason why institutional investors and those in the know have been throwing billions into TIPs.
When the pros are throwing billions of dollars at something, they are doing it for a reason. The general retail investor is usually missing the memo. Professional financial planning tips from SFS is all about making sure that inflation is not a variable in your equation.
Professional portfolio managers understand the importance of inflation hedging and TIPs are becoming the new standard of excellence.
Understanding The TIPs Market Explosion
The TIPs market is not just growing, it is experiencing record-breaking demand.
Treasury auction sizes have been through the roof. The reopening auction for 10-year TIPs increased from $18 billion to $19 billion.
Right now, Treasury rates are currently hovering around 4.3%.
With real rates (post-inflation) not being seen in years. TIPs are offering real returns, and that is only a new opportunity for smart investors.
TIPs are a super attractive investment when there is uncertainty about future inflation levels. Given the current political climate and the amount of stimulus and money being pushed out there is a good chance that inflation is about to go up even further. This means that smart investors should start adjusting their portfolios now.
The breakeven rate for 5-year TIPs is currently 2.4%. If inflation averages that amount or more over the next five years, then TIPs outperform standard Treasury securities.
How To Allocate TIPs For Maximum Protection
Smart TIPs allocation is not putting all your eggs in one basket.
A great allocation strategy will create a balanced and well thought out approach that protects your wealth. But also allows you to make gains and grow your capital.
This is the framework that is recommended:
The Core-Satellite Approach
This is the idea of starting with TIPs as your base inflation protection. The majority of the experts suggest that you allocate 10-20% of your fixed-income allocation to TIPs. But the percentage is also subjective to your risk tolerance and time horizon.
If you are a conservative investor it recommends 20-30% of your total portfolio to be in TIPs. 10-20% for moderate and aggressive investors 5-15%.
Time Horizon
Time horizon is key in TIPs investments. TIPs work best for longer periods.
If you are investing for a longer term goal like retirement in 20+ years, TIPs can be excellent in wealth preservation.
Shorter-term investors are to focus on shorter duration TIPs.
Long-term investors will benefit from a healthy mix of 10-year and 30-year TIPs.
Direct Purchase or Funds
There are two main methods for TIPs investments.
- Direct purchase through Treasury Direct – this is buying individual TIPs for $100
- TIPs mutual funds or ETFs – this will give you professional management and diversification
Buying directly works well for most that have plans to hold TIPs to maturity.
Mutual funds or ETFs are great options if you want flexibility in your portfolio.
Strategic TIPs Integration Methods
The best TIPs allocation strategy will use a combination of the methods that we have discussed.
Laddering Strategy
A laddering approach to TIPs can work well to give you a stable income from TIPs maturing each year. It also works to protect your portfolio against interest rate changes.
This strategy will also give you the flexibility of reinvesting your money at different points in time.
Rebalancing Triggers
TIPs allocation triggers that we need to set when we want to increase our TIPs allocation and when we want to decrease it.
Increase TIPs when inflation expectations are more than 3% or when real yields become attractive.
Decrease TIPs when deflation becomes a threat or when real yields turn deeply negative.
Tax Considerations
TIPs have an element of taxable income as a result of the inflation adjustments to principal and the interest payments. Remember that the principal inflation adjustments aren’t payable until maturity.
Smart Investor Tip: TIPs work best when held in tax-deferred accounts such as 401(k)s or IRAs.
Avoiding Common TIPs Allocation Mistakes
Even the smartest investors can be guilty of the following mistakes…
Mistake #1: All-Or-Nothing Thinking
TIPs are great but are not meant to be your entire fixed-income allocation. Diversification is your best friend in investment.
Mistake #2: Ignoring Duration Risk
Investors are more sensitive to interest rate changes in the long term. It is not advisable to put all your eggs in 30-year TIPs.
Mistake #3: Chasing Performance
TIPs can be very volatile in the short-term. It is not advised that you try to time the market. It is best to stick to your strategy and take your long-term profits.
Building Your TIPs Allocation Plan
Are you ready to build your TIPs allocation plan?
Here is your step-by-step action plan:
- Assess your inflation risk – Calculate your current expenses that are subject to inflation
- Determine your time horizon – Longer time horizons benefit most from TIPs investments.
- Choose your allocation percentage – Start with 10-15% of your total fixed-income allocation.
- Select your preferred TIPs strategy – This will be either direct purchase or funds.
- Implement gradually – This will be accomplished through the dollar-cost averaging approach over a period of 6-12 months.
The most important point is to start now.
Wrapping It All Up
A strategic TIPs allocation builds a solid strategy for wealth protection to ensure your purchasing power is intact for decades to come.
There is a reason why the TIPs market has grown to a whopping $2 trillion in recent years. Smart investors know that inflation protection is critical to your investment strategy.
The 4 smartest investor tips that you can use:
- 10-20% of your fixed-income portfolio should be in TIPs
- Shorter-maturity TIPs are ideal for building a healthy mix
- You should always have your TIPs in tax-deferred accounts where possible
- Rebalance when economic conditions require a change in your allocation
TIPs might not make you a millionaire but, at the very least, TIPs ensure that the wealth that you have already built maintains its purchasing power for decades to come.
This is the key to real long-term financial growth.
