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Concerned About Inflation? Consider TIPS

Inflation has been relatively low for the last decade, but the economic stimulus packages and recovery from the pandemic are expected to heat up the U.S. economy.1 Even so, the Federal Reserve has indicated it will let inflation run above the Fed’s 2% target for some time before raising interest rates.2

It’s unlikely the Fed will let inflation get out of control, but even moderate inflation can reduce purchasing power and erode the value of your investments over time. Inflation can be especially challenging for retirees living on a fixed income.

Moving with the CPI

One way to help provide protection against inflation is through Treasury Inflation-Protected Securities (TIPS). The principal value of TIPS is automatically adjusted twice a year to match any increases or decreases in the Consumer Price Index for All Urban Consumers (CPI-U). If the CPI‑U moves up or down, the Treasury recalculates your principal to reflect the change.

A fixed rate of interest is paid twice a year based on the current principal, so the amount of interest may fluctuate. Thus, you are trading the certainty of knowing exactly how much interest you’ll receive for the potential that your investment will maintain its purchasing power over time.

Pricing-In Protection

TIPS pay lower interest rates than equivalent Treasury securities that don’t adjust for inflation. The breakeven inflation rate is the difference between the yield of TIPS and nominal (non–inflation protected) Treasury securities with similar maturities. It is the cost for inflation protection and also a market-based measure of expected inflation. If inflation runs higher than expected, TIPS typically will earn a better return than nominal Treasury securities. If the inflation rate runs below the breakeven rate, then TIPS have no clear advantage. However, the increased principal due to any level of inflation can still add to the value of your portfolio.

In the current low interest-rate environment, TIPS may have negative interest rates that might produce a positive return after the principal is increased for inflation. For example, at the beginning of July 2021, a 5-year TIPS offered a return of –1.60% while a 5-year Treasury note offered a return of 0.89%.3 The 2.49% difference between these rates is the breakeven inflation rate. If inflation were to run at 3%, the TIPS would return 1.40% (3% – 1.60%) after adjustments for inflation, about half a percent higher than the return on the Treasury note.

Eroding Purchasing Power

Over the past 50 years, inflation has averaged almost 3.9%, with wide variations including runaway inflation from 1973 to 1981. More recently, inflation has been lower and relatively consistent, averaging about 2% over the last 20 years. In the spring of 2021, inflation started trending higher.

The U.S. inflation rate was 13.3% in 1979, fell to 0.1% in 2008 and climbed to 1.4% in 2020.

Source: U.S. Bureau of Labor Statistics, 2021 (based on December to December change in CPI-U)

TIPS are sold in $100 increments and are available in maturities of 5, 10, and 30 years. Like all bonds, the return and principal value of TIPS on the secondary market vary with market conditions, are sensitive to movements in interest rates, and may be worth more or less than their original cost.

When interest rates rise, the value of an existing TIPS will typically fall on the secondary market; when rates decline, the value of a TIPS will typically rise. Changing rates and secondary-market values should not affect the principal of TIPS held to maturity.

All Treasury securities, including TIPS, are guaranteed by the federal government as to the timely payment of principal and interest. You must pay federal income tax each year on the interest income from TIPS plus any increase in principal, even though you won’t receive that money until they mature. For this reason, it may be preferable to hold TIPS in a tax-deferred account such as an IRA.

Information provided has been prepared from Broadridge Advisor Solutions sources and data we believe to be accurate, but we make no representation as to its accuracy or completeness. Data and information is provided for informational purposes only, and is not intended for solicitation or trading purposes. Broadridge Advisor Solutions is not an affiliate of Equitable Advisors, LLC. Please consult your tax and legal advisors regarding your particular circumstances. Neither Equitable Advisors nor any of the data provided by Equitable Advisors or its content providers, such as Broadridge Advisor Solutions, shall be liable for any errors or delays in the content, or for the actions taken in reliance therein. By accessing the Equitable Advisors website, a user agrees to abide by the terms and conditions of the site including not redistributing the information found therein.

Securities offered through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC. Annuity and insurance products offered through Equitable Network, LLC and its subsidiaries.

Nathan L. Moore has earned the Retirement Planning Specialist (RPS) title. The Retirement Planning Specialist title is awarded by Equitable Advisors, based upon the Financial Professional's (FP) receipt of a Certificate in Retirement Planning from the Wharton School, University of Pennsylvania. In a collaboration between the Wharton School and Equitable Advisors' affiliated life insurance carrier, coursework for the certificate was developed exclusively for Equitable Advisors FPs, and the title may be used only by FPs who have completed the required coursework and maintain the title through ongoing continuing education requirements. To verify that an FP has earned and holds the title in good standing, contact us at atretirement@equitable.com. Complaints about an Equitable Advisors FP should be directed to customer.relations@equitable.com.

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