The Basics of Inflation Linked Bonds

Inflation linked bonds are type of bond that are designed to help investors combat inflation in their portfolios. This type of investment can be very beneficial and provide you with several advantages over other types of investments. Inflation is one of the biggest problems that investors have to deal with on a regular basis. Inflation is going to reduce the amount of value that you receive from any investment that you take on.

Inflation 

Inflation takes a big chunk out of the returns that you can earn as an investor. For example, if you invest in a stock that provides you with 10 percent return and inflation is three percent for the year, you are only going to net a seven percent gain. In some cases, inflation can actually outperform your investments if you invest in low yield securities. For example, if you put money into a savings bond, there is a good chance that inflation is going to increase at a higher rate than the interest that you are being paid. Because of this, investors have to pay attention to inflation and the negative effect that it can have on your portfolio.

Inflation Linked Bonds

Inflation linked bonds are a type of bond that will increase in value, depending on how much inflation occurs over the course of a year. This type of bond is designed to protect investors against inflation. These bonds are sold by the United States government in two different forms. You can buy savings bonds or you can buy TIPS. The term TIPS stands for Treasury Inflation Protected Securities. 

Consumer Price Index

In order to determine how much inflation has occurred over a certain amount of time, the Treasury reviews the Consumer Price Index. The Consumer Price Index is an index that looks at how much it costs to maintain a specific standard of living in the United States today. It looks at many different products that are in the market place and compares the current cost to the previous cost. Then, they take an average of the difference. Bonds will pay a certain amount of interest depending on how much inflation has occurred every six months. 

Beating Inflation

These bonds are designed to help you barely beat inflation. You are going to get a small, fixed interest rate, such as 1 percent per year. Then, in addition to the fixed interest rate, you are going to get an adjustment based on the inflation rate for the year. This provides you with a payment equal to inflation and then you get the additional fixed interest rate on top of the amount of inflation that has occurred over the last six months. The amount that is added is usually a nominal rate so your growth is stunted. Inflation is a dangerous weapon against bonds so when the bond is linked to inflation in an effort to protect your investment, it is a good thing and well worth some consideration.

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