You don’t have to let inflation control your profits.
Is inflation good or bad for individual investors? The answer is that it depends. Inflation can eat away at your purchasing power and your stock returns, or it can become an investment opportunity. This article will introduce you to an interesting exchange traded fund (ETF) that can help you increase your protection against the problems of rising inflation while leveraging the opportunity to profit.
The US Treasury sells notes of different yields, maturities and terms. One type of those notes are known as TIPS or Treasury Inflation Protection Securities. A TIPS note’s yield is increased or decreased based on changes in the level of CPI or consumer price inflation. If CPI or inflation is rising, the face value of a TIPS note increases and similarly the face value may fall if CPI falls.
This means that TIPS are a hedge against inflation. As prices rise, the value of a TIPS note increases offsetting some of those losses due to inflation. The interest paid on the bond also increases as it is paid on the new increased value. You can buy TIPS from the Treasury through Treasury Direct or from your broker, which is a fine alternative but there is a way to do this through the stock market as well through a TIPS ETF (TIP). You can see this ETF compared to the S&P 500 in the chart below. As you can see, TIP has outperformed the stock market during the last 12 months, which is not surprising considering the recessionary environment in the US.
Daily Chart S&P 500 (Red) / TIP (black)
From a fundamental and technical perspective it seems that one of the few things we can count on in this environment is higher levels of inflation in the long term. That may make the TIP ETF an attractive mid-term value play after the correction of the past few months. From a portfolio management perspective this is a good way to add protection against inflation and to insert an element of fixed income to your diversification strategy.
Bottom line: Higher rates of inflation are either a problem or an opportunity. Which it really turns out to be is up to you as the investor.