This inflation-protected investment looks attractive now, but you should proceed with caution

Yields on Treasury inflation-protected securities are looking attractive, but investors should slow down before bulking up on these assets. These so-called TIPS are government bonds that offer protection against inflation. Their principal rises and falls alongside the movement in the consumer price index. This makes them an attractive instrument for older investors who might be in the process of spending down their savings. “People who are still working and earning a salary eligible for cost-of-living adjustments shouldn’t sweat much about having inflation protection, but older adults should think about it as a portion of their portfolios,” said Christine Benz, director of personal finance at Morningstar. Indeed, investors scooped up TIPS as inflation hit decades’ long highs, but they began dumping the bonds , betting that the Federal Reserve will be successful in slowing the pace of rising prices. Meanwhile, yields on TIPS are ticking higher: The rate on 10-year TIPS topped 0.9% on Friday. The run-up in yields recently caught the attention of Joseph Kalish, chief global macro strategist at Ned Davis Research. Bond yields move inversely to prices. “TIPS yields are relatively attractive on an absolute basis and modestly undervalued on a relative basis,” he wrote in a Tuesday note. Changing inflation expectations Jamie Cox, managing partner at Harris Financial Group, only thinks TIPS potentially work if inflation is persistent — and prices seem to be on their way down. The Federal Reserve, which has been raising rates to bring down inflation, isn’t backing down and ” will keep at it until the work is done,” Chair Jerome Powell said Thursday. At the same time, inflation is abating on its own as the pandemic-related effects on the economy ease, Cox noted. “A lot of the pieces of the inflation equation are coming down and coming down hard,” he said. “Buying inflation protection right now is probably a little bit too late.” Rather than using TIPS for short-term needs, Cox recommends cash, certificates of deposit and T-bills. Further, equities are a better way to combat inflation, but the risk profile is different from fixed income, said Brenna McLoughlin, CFP and senior advisor at Wealthstream Advisors. For those in or near retirement, she looks at several building blocks, none of which include TIPS. She starts with having enough cash or cash equivalents, including T-bills, to live off of for one or two years. Then she suggests short- to intermediate-term bonds and, finally, equities to help produce income for later in retirement. Using TIPS sparingly Consider the role fixed income plays in your portfolio and your time horizon for investing. “For all things fixed income, we want to keep a relatively short duration,” said Charles Failla, certified financial planner and principal of Sovereign Financial Group. Duration measures the sensitivity of the bond’s price to a change in interest rates. Long-term bonds tend to be the most sensitive to rate hikes and cuts. He recently added to his clients’ TIPS allocation through low-cost exchange traded funds. The inflation-adjusted instruments now make up 8% of the fixed income portfolio, up from 4%. “We’re not completely loading the boat on that investment,” he said. “We like them more than we did a few years ago, but that’s not to say you zero out everything and go there.” Other corners of the fixed-income market he likes include short-term high quality corporate bonds. See below for a chart of TIPS funds. Older investors focusing on inflation protection may want to first pick up Series I savings bonds – or I bonds, which are offering an initial interest rate of 9.62%, said Benz. “From there, assuming you feel you need a bigger bulwark against inflation, you look to TIPS,” she said. Investors can purchase TIPS directly from the federal government through TreasuryDirect.gov in $100 increments and in terms of 5, 10 and 30 years. However, you can find TIPS funds in a range of maturities, and you do have the benefit of professional management — rather than trying to spot buying opportunities. Be price conscious when choosing a TIPS fund, and keep an eye out for potential price dislocation as rates rise. “Not trying to get cute with the timing decisions makes sense to me,” Benz said. “I think as long as you have calibrated your time horizon and used the right type of TIPS fund for that time horizon you should be OK.”