You needn't panic if you get some bad TIPS


Your Money


With all the fretting about inflation during the past few months, you might think that a TIPS mutual fund would be just the ticket.

After all, TIPS, or "Treasury inflation-protected securities," are U.S. government bonds structured to help you weather inflation. Twice a year, the government automatically adjusts the bonds so the returns keep up with inflation.

But if you have a TIPS mutual fund in your portfolio, you might be surprised to see your next statement. Rather than seeing the protection you expected, you are likely to spot a loss. If you have other bond funds, too, the shock might be even greater.

TIPS funds aren't just disappointing. They have been the worst of all bond funds during the past year, according to Lipper Inc.

The average TIPS fund lost 2.6 percent during the 12 months ending June 30, while the average intermediate-term U.S. government bond fund lost 1 percent, according to Lipper. For the first six months of the year, TIPS lost 2.4 percent, while government bond funds lost 0.84 percent.

It's a reminder that bonds are not as safe as investors often think; they are certainly not comparable with money market funds. Bond prices are vulnerable when the Federal Reserve is raising interest rates, as it has been doing for two years. And investors feel the effects most when bonds are in mutual funds, rather than held individually. That's because each day, the fund's value is calculated to show what investors are willing to pay for bonds. Individuals who buy single bonds and hold them until they mature often don't notice the price fluctuations.

Yet investors shouldn't panic at the sight of negative numbers in their TIPS funds. The recent losses don't mean your bond fund manager is a failure. When interest rates are climbing, fund managers have strategies they can use to moderate losses, but, typically, old bonds lose value when newer bonds are paying more interest.

There's only so much a fund manager can do to avoid the impact. That's true whether your fund invests in TIPS, U.S. Treasury bonds or corporate bonds.

"TIPS got whacked the hardest" because their yields were so low when interest rates started climbing, said Morningstar bond fund analyst Eric Jacobson. When yields began rising, the changes were large in proportion to the small yields, so that "caused exaggerated price pain."

Also, TIPS tend to mature over long periods, and any bond that has 10 or 20 years to go before it matures is hit harder by rising rates than a bond maturing in two or three years, Jacobson said.

While TIPS yields are adjusted by the Treasury based on the consumer price index, the prices that investors are willing to pay for the bonds are affected day in and day out by their outlook for inflation, said John Brynjolfsson, manager of the Pimco Real Return bond fund. So, on any given day, the price can be higher or lower based on sentiment.

During the past few months, TIPS prices have been held down by the perception that the recent spike in inflation is temporary, largely a result of Hurricane Katrina, Brynjolfsson said.

Despite the prices for TIPS, investors should realize they are getting inflation protection, Jacobson said. So the effects of inflation won't erode the buying power of money that is invested in TIPS bond funds for many years.

Still, if investors guess right about inflation, they might do better buying Treasury bonds rather than those that adjust for inflation. That's because Treasuries pay a higher fixed rate than TIPS, while TIPS currently pay a lower rate and will adjust higher only with increased inflation.

Messages for Gail MarksJarvis can also be left at 312-222-4264.

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