Treasury inflation-protected securities (TIPS) are securities that are designed to help protect against the damaging effects of rising costs. Exchange-traded funds (ETFs) focused on investing in TIPS now contain more than $24 billion in assets.
Inflation-protected securities operate very similarly to traditional bonds in that they have predetermined times to maturity and interest rates, but their principal balances are adjusted periodically to account for the current rate of inflation.
For example, consider an individual who invests in a $1,000 TIPS with an interest rate of 5%. If inflation during the year comes in at 2%, the principal balance of the bond would be adjusted to $1,020. On top of the principal adjustment, the bondholder would also receive $50 in interest payments. TIPS are designed to protect against inflation risk, not interest rate risk. TIPS will still fall in value in an environment of rising interest rates and can lose value over time.
With low inflation and low interest rates, the average yield from TIPS funds is only around 0.4%. Even though inflation is very tame currently, TIPS have become popular among income-seeking investors. Looking for TIPS products that limit risk and expenses while achieving their stated objectives is the best course of action.
Schwab U.S. TIPS ETF
Expenses are the enemy of mutual fund and ETF investors since they eat directly into investors' returns. The Schwab U.S. TIPS ETF (NYSEARCA: SCHP) makes an ideal choice, as it is the cheapest TIPS fund in the marketplace as of Nov. 18, 2015.
Launched in 2010, this fund has an expense ratio of just 0.07%. This fund falls a bit on the riskier end, with a duration of nearly eight years. Therefore, this fund could especially impacted if interest rates start rising.
Vanguard Inflation-Protected Securities Fund Admiral Shares
The Vanguard Inflation-Protected Securities Fund is a mutual fund that combines the best of low expenses and strong performance. This fund charges an ultra-low expense ratio of 0.1% and is one of the few TIPS-focused mutual funds that earns Morningstar's prestigious five-star rating.
The Admiral class of shares of this fund comes with a minimum investment of $50,000. Investors without that much to start out with can instead opt for the lower minimum Investor shares that come with a slightly higher expense ratio.
IShares TIPS Bond ETF
Of all the money invested in TIPS ETFs, over half is managed in this ETF alone. The iShares TIPS Bond ETF (NYSEARCA: TIP) has over $13 billion in assets and charges 0.2% in expenses.
This fund is the largest and oldest TIPS ETF, having launched in 2003. It also falls on the lower end of the risk spectrum. The number of shares traded daily makes it the most liquid fund, which helps to limit trading costs.
FlexShares iBoxx 3Yr Target Dur TIPS ETF
The Federal Reserve may begin raising interest rates as early as 2015. As interest rates move up, bond prices move down, making it a wise choice to try to limit interest rate risk.
This FlexShares iBoxx 3Yr Target Dur TIPS ETF's (NYSEARCA: TDTT) risk level comes in much lower than average, as it focuses only on short-term TIPS. This risk minimization strategy has proved beneficial recently, as the fund has been one of the better-performing TIPS ETFs.
iShares Global Inflation-Linked Bond
The iShares Global Inflation-Linked Bond (NYSEARCA: GTIP) is one of the few TIPS funds that indexes to global inflation rates instead of just the domestic inflation rate. The economy in areas such as Europe and China has been less than kind lately and, as a result, this fund has been one of the worst performers in this market segment. However, its expense ratio of 0.4% is comparatively low for an international product.
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