Are TIPS mutual funds a risky investment?

The answer is a resounding yes – there is risk. And I think that the TIPS mutual funds and ETFs are especially risky right now, even though they are very popular. You see them recommended as ‘inflation fighters’ in magazines every month.

(I recommend holding TIPS directly to maturity, no risk in that investment, unless you worry that the Treasury is going to default. You may lose out on some potential interest, but you won’t lose your money.)

Look at this five-year chart of the TIP ETF:

1) We are sitting very close to a 5-year high for this ETF.

2) The base-rate paid on 10-year TIPS is very low, based on history. When that base rate starts rising, TIPS mutual funds will lose value.

3) A more normal value for this fund appears to be around 100, instead of the current 108.61.

This part of the chart is the most interesting:

During the financial crisis of 2008, there was a sudden fear of deflation, meaning negative returns on TIPS. So bond buyers began demanding a premium on the base rate, which was driven from less than 2% before the crisis to about 3.5% at the peak of the crisis.

This peak of fear was a excellent time to buy TIPS and TIPS mutual funds. I bought into Vanguard’s TIPS fund on Dec. 1, 2008 at $11.14. It is now $13.21, a capital return of 18.5%, on top of the interest payments.

You can’t expect returns like that from a TIPS fund — I actually switched out in September 2009 at 12.44, into the Total Bond Fund, which looked a little less risky.

(How did I do on that? Pretty much a wash. Vanguard TIPS (VIPSX) returned 6.17% in 2010, while Total Bond (VBMFX) returned 6.42%.)

The point is … if a TIPS fund can give you capital return of 18% in two years, it can also give you an equal loss. There is risk, and since the base rate is so low right now, I think these TIPS funds are risky.

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One Response to Are TIPS mutual funds a risky investment?

  1. Pingback: New ETF entries … International TIPS funds | Treasury Inflation-Protected Securities

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