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THE REICH REPORT

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I’m hearing a lot more discussion lately about the use of TIPS (Treasury Inflation-Protected Securities) going into people’s portfolios due to the expectation of higher interest rates. This week I wanted to discuss why that might not be a good idea. What is a TIPS?

TIPS are Treasury bonds that are linked to inflation so that the interest payments rise (or fall) with changes in the CPI (Consumer Price Index). On first pass, it isn’t hard to see why so many people are adding TIPS to their portfolios. If an individual TIPS is held until maturity, then the full value of the bond would be received at the maturity date. Most people, however, don’t hold TIPS or other bonds until maturity. Often TIPS like other bonds are held as a part of a mutual fund or ETF. Individual holdings inside of these funds are typically bought and sold before the actual maturity date. This can result in a gain or loss on the underlying bond.

If everyone thinks rates are going up, then why wouldn’t TIPS be a great solution? For starters, TIPS are designed to help protect investors from the expectation of rising rates but are less effective from the actual real rise in rates. This is an extremely important distinction that almost all investors get wrong. I always compare this difference to when I hear people say “money is the root of all evil”, when in reality the real quote is “the love of money is the root of all evil”. There’s a big distinction there. The same goes for TIPS, it’s the expectation not the actual rise.

Risks to TIPS include rates rising without inflation following along. In this case, TIPS may offer no help. Another consideration is that while the CPI tries to track inflation, it rarely ever gets it exactly right. An actual inflation rate that is higher than the CPI would not fully protect investors. To me, one of the main reasons I don’t love TIPS is because Fed policy is in almost direct conflict with the way TIPS perform best. If inflation is rising, the Fed uses interest rates to try to lower inflation (and expectations for inflation), or at least outpace inflation. This policy is clearly not good for TIPS. How many times have you heard the phrase “don’t fight the Fed”? Well, TIPS are doing just that, trying to fight the Fed. Also, major market declines can lead to brief periods of deflation which is really bad for TIPS. We saw this during the 2008 crash and aging at the beginning of the pandemic. During these times, TIPS prices became very volatile and many investors may have panicked and sold them.

So, are TIPS not a good investment? No, that isn’t what I’m saying at all. TIPS have performed better than regular Treasuries during periods of rising interest rates, but that isn’t saying much and they aren’t necessarily going to provide you with the returns you were expecting just because inflation is going up. The reality of the current environment is that real interest rates are low and the expectation for rates is already higher so I believe buying TIPS today would be missing the boat, because I think higher inflation expectations are already priced in.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.

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