How to Guard Against Inflation Through TIPS

(MoneyWatch)  With inflation fears rising due to our government's economic stimulus, Treasury inflation-protected securities (TIPS) are getting much more attention in the media. This is good, as TIPS are an excellent choice for many investors' portfolios. Here are some things to consider when adding TIPS to your portfolio.

As discussed in my book The Only Guide to Alternative Investments You'll Ever Need, the conclusion of the academic research on TIPS is that you should strongly prefer real return bonds over nominal return bonds. There are two ways to include TIPS in your portfolio:

• Invest in a TIPS fund
• Buy individual securities

Invest in a TIPS fund
Using a fund provides two significant benefits: convenience (including reinvestment of interest) and diversification across maturity. And these benefits come with very low costs. Right now, there are three funds that I believe you should consider if you go the fund route: Vanguard Inflation-Protection Securities Fund, DFA Inflation-Protected Securities Portfolio and iShares Barclays TIPS Bond Fund. Each has an expense ratio of less than 0.25 percent, invests across a spectrum of outstanding TIPS and has an average maturity of about nine years.

Buy individual securities
By buying individual TIPS, you not only eliminate the expense of the fund, but you can also control the maturity of the bonds you buy. For example, when real yields are at historically high levels (such as in October, when they reached well over 3 percent), you might consider buying longer-term TIPS to lock in the high real yield for a long time. On the other hand, when real yields are at historically low levels (such as in March 2008, when the real yield on some TIPS even turned negative), you might not want to own TIPS with an average maturity as long as nine years, as do the funds.

While you can buy TIPS through a bank or broker, you can also buy them directly from the Treasury.