Inflation Protected Securities - Explained
What are Inflation Protected Securities?
Written by J. Mance Gordon
Updated at April 22nd, 2024
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What are Inflation Protected Securities?
In trading parlance, Inflation Protection is the adjustment of value in the price of securities, with respect to inflation. Prices of securities, their payouts, and dividends, are adjusted periodically in keeping with the rate of inflation. Inflation is the rise of prices for goods and services.For e.g., A health insurance contract that carries a price adjustment clause in case of an increase in the prices of medical services.
How Do Inflation Protected Investments Work?
Inflation Protection mitigates the risk of inflation on an investment portfolio by diversifying it. Common instances of Inflation Protection are:
Treasury Inflation Protected Securities (TIPS)
Treasury Inflation Protected Securities TIPS are securities adjusted for inflation. The price value of the security is adjusted in the Consumer Price Index with respect to fluctuating inflation rates, while the interest on it remains fixed on the treasury. This makes Inflation Protected Securities available at very low risk factor as well as low interest rates in the bonds market.TIPS perform well during rise in inflation. Conversely, ROI on TIPS is low if theres no rise in inflation during the lifetime of these securities. They also require tax adjustments in accordance with the adjustments made due to inflation.
Inflation Protected Commodities
Some Commodities like gold are used to hedge against inflation as the price of commodities is directly proportional to inflation. Returns on Inflation Protected Commodities are better than TIPS, as TIPS tend to have a lower interest rate. The downside to this is that Commodities carry the risk of reduced production and regional output. Other factors may also influence the sensitivity of commodities overtime to inflation. An alternative way of hedging against inflation in commodities prices is to invest in stock options of companies that produce these commodities.