Wednesday, February 27, 2008

TIPSing Over?

"Inflation's a big risk to your savings. But inflation-protected bonds are an even bigger risk these days. ... Many investors, and their financial planners, are reacting to the danger by rushing into what they think is a safe haven: ... TIPS. It's a bad move. ... In theory, TIPS are an excellent idea. Like all bonds issued by Uncle Sam, they are safe from default. But unlike other Treasurys, they are also supposed to be safe against rising prices as well. ... This 'real,' or after-inflation, yield is locked in when you buy the bond. And right now, those real yields are terrible. They recently touched record lows. ... For the seven-year bond it's just 1.23%, and for the five-year, a crazy 0.78%. Early last fall, long TIPS guaranteed a respectable 2.3% plus inflation. ... Imagine inflation rises to 5%. Your 10-year TIPS, with its 1.56% 'real' yield, will therefore pay 6.56%. But that's taxable. At the top 35% rate of federal income tax, you will actually get only 4.26% a year. And that, of course is well below the inflation rate. A guaranteed negative real return. In this scenario, only those below the 25% federal income tax rate come out ahead", Brett Arends (BA) at the WSJ, 21 February 2008.

BA nails it. TIPS are a very bad buy at current prices. For that matter, all US dollar long-term bonds are bad investments currently. See also my 5 October 2007 post.

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