Opinion: CPI? Who cares? This is why I love my inflation-protected bonds.

Why so many people carry on owning old-fashioned bonds with no inflation protection is beyond me. Who needs the stress? Who wants to take the risk?

To me, it’s like driving without a seat belt, or listening to music on cassettes. I know that’s what everyone used to do. But haven’t we moved on?

The latest inflation figures show that prices have risen 3.1% over the past 12 months. In the last month — from December to January — prices rose at an annual rate of 3.7%. That’s nearly twice the Federal Reserve’s target level of 2%.

Take a look at recent data. From September to October, that annualized rate was 1%. Last summer it hit 6.3%. At a few points in 2022, it was well above 10%. At several points since then it’s fallen below 1%, then zoomed back up again. At one point it briefly went negative.

Who needs this?

At current prices, regular old-fashioned 10-year Treasury notes are promising to pay 4.27% a year for 10 years. But that figure is meaningless. What will those dollars be worth? What will happen to inflation between now and then? If I buy these notes and consumer prices rise by 4.27% a year or more, my actual interest rate will be 0% — or possibly even negative.

That’s before fees and taxes, too.

I will only get 4.27% a year if inflation comes in over the next 10 years at 0%.

Call me crazy, but I’m guessing that’s not going to happen. 

In other words, the posted interest rate on regular Treasury bonds is either meaningless, misleading or a lie — depending on your point of view.

The same is true of certificates of deposit. People rave about CDs paying 5%, but if each dollar you get back buys you 5% less, what have you really made? 

The latest acceleration in inflation means the real interest rate you’ll get on your bonds and your CDs just fell. In October, when prices seemed to be rising by 1% a year, that 5% CD looked like it was going to pay 4% in real spending-power terms. Now, with inflation at 3.7%, maybe it will only pay 1.3%. 

None of this makes any sense. Most of the people who buy bonds — especially all of us doing so in our retirement funds — are doing it for security and stability. We’re not trying to make bets on what the next move in interest rates will be. Bonds are known as fixed-income investments because, er, the income rate is supposedly fixed.

Back in the era of tight money, this was a distinction without a difference. Inflation before World War I was typically low, flat or negative. Government spending was very small, as were deficits, and the money supply was tied to gold reserves. That was bad for many things, but great for regular bonds.

No longer.

Since 1913, inflation has averaged nearly 4% a year. So just how exciting is a 10-year Treasury note paying less than 4.3% a year? Be still my beating heart.

I’ve written about inflation-protected bonds before. I make no apologies for returning to the subject. They were first invented in the early 1980s in Europe. Here in the U.S., Uncle Sam has been producing them since the late 1990s. They are called Treasury Inflation-Protected Securities, or TIPS, and they remain a remarkably niche product. Old-fashioned regular or “nominal” Treasury bonds are vastly more popular.

All of my bonds are inflation-protected. Every single one. I bought individual TIPS bonds through my brokerage account. Most people are going to be better off buying them through a low-cost fund, such as the Schwab U.S. TIPS exchange-traded fund
SCHP,
SPDR Portfolio TIPS ETF
SPIP
or iShares TIPS Bond ETF
TIP.

Buying the individual bonds can be a pain in the neck, because the market is so thin. Sometimes I seemed to be the only person buying.

I hold all my TIPS bonds in tax-sheltered accounts, in either my 401(k) or my IRA. For various technical reasons, TIPS are tax-unfriendly. I am much better off holding my TIPS in my tax shelters and if need be holding some of my stocks in my taxable accounts, than the other way around.

What do the latest inflation numbers do to inflation-protected bonds? Well, in the short term, they cause volatility, as they do to other bonds. TIPS index funds fell about 0.6% on Feb. 13. Long-term TIPS, in line with other long-term bonds, fell more: The Pimco 15+ Year TIPS Index ETF
LTPZ,
for instance, fell just over 1%. There are various technical reasons for that, including market connections between regular and inflation-protected bonds, and changing expectations about what’s going to happen to short-term rates.

But that would only matter to me if I were trading my bonds. I’m not. These are the bonds in my retirement account. I plan to hold them for years — maybe even until they mature. And from that point of view, changing inflation numbers mean … absolutely nothing.

I bought my TIPS bonds when the guaranteed real, or inflation-adjusted, interest rate was between 2% and 2.5%. So that’s what I’m going to get if I hold them to maturity, come hell, high water or hyperinflation. So long as the federal government doesn’t actually collapse and stop paying its bills, I’m golden. 

I’m looking at the TIPS market right now. Anyone buying them today is getting a real, inflation-adjusted yield of between 2% and 2.2%, depending on the maturity. By historic standards that’s either good, very good or excellent, depending on how you look at it. Buy a five-year TIPS bond at 2% and your investment is guaranteed to be worth 10% more — you’ll be able to buy 10% more stuff — when it matures in 2029. Buy the 10-year TIPS bond, and in a decade you’ll be able to buy 23% more stuff. And so on.

How much stuff will you be able to buy with your regular bonds? You have no idea. Nor does the Fed. 

But, hey, if you want to gamble, go right ahead.