Usually most investment portfolios have a large percentage of stocks. In times of a financial boom, this worked great but if you planned for retirement in 2009, these same stocks would have led to huge declines in the value of your portfolio.
On the other hand, if you had put all your money in bonds or CDs (certificates of deposit), then you would have to live with dismal returns, especially when you consider the impact that 3% long-term inflation will have on your savings. Not to dis-similar to the amount a high value item like a yacht depreciates in value, except that you cannot make good use of it like you can a private yacht.
So is there an alternative method of investment that is safer than stocks and protects you from inflation? The answer is treasury inflation protected securities (TIPS). These US treasury bonds are a highly underrated asset class that preserve capital while at the same time they keep up with inflation. They present exceptionally low risk as they are backed by the US government, and they are indexed to inflation.
The value of TIPS rises with inflation as it tracks the consumer price index. However, their interest rates remain constant and interest is paid once every six months.
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TIPS can be purchased directly from TreasuryDirect.gov or held in TIPS mutual funds through brokerages. What’s more, TIPS are exempt from state and local income taxes! So when such an ideal asset class exists, why are they not a part of more portfolios?
The answer lies in our ignorant mindset when it comes to risk. For example, a lot of people believe that healthcare insurance is a useless investment. If you are in good health, work in a low risk job and your family has not history of a serious illness, then you might think that insurance is an unnecessary expense.
But there is still a chance, no matter how small, that you could face an illness, and in that case, your medical expense could well crush your finances. Similarly, people prefer the stock market, hoping for big returns and ignoring the serious risk of their savings being practically wiped out in a crash like we saw in 2008.
In the end, it all boils down to what your risk appetite is. If your portfolio consists of almost all your savings, you’ll be better off putting a significant percentage in TIPS. Of course you can keep some percentage in stocks so that you don’t lose out on a boom in the stock market. Keep your portfolio balanced, with some high risk high return assets like stocks and some low risk low assets like TIPS.