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What are Inflation Bonds?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 26 January 2020
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    Conjecture Corporation
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Also known as Treasury Inflation-Protected Securities or TIPS, inflation bonds are a specific type of government bond issue offered in the United States. First introduced in 1997, the idea behind this debt security was to protect investors from the ill effects that occur when an economy is moving through a period of inflation. While originally promoted as a means of saving for retirement without worries of the investments losing value over the years, critics of this particular bond issue doubt its ability to offer the protection in face of severe and prolonged inflation.

Inflation bonds are sometimes referred to as inflation-indexed bonds, based on the manner that the coupon rate associated with the bond would fluctuate as the rate of inflation shifts. In some ways, the idea is for the bonds to respond to market conditions much in the way that an adjustable rate mortgage responds to movements of the average rate of interest. This would allow the bondholder to take advantage of periods in which rates were higher, while still creating a floor rate that applies to the bond itself.

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For investors who are concerned about inflation having an adverse effect on the value of their investments, inflation bonds appear to be a good option. Like most bonds, the potential rate of return is somewhat limited in comparison to other investment options. At the same time, the structure of inflation bonds does establish a minimum return that will be realized regardless of what direction the economy takes at any given point in time. This is accomplished within taking on the amount of risk that is commonly associated with other types of investments, including stocks, commodities, or trading in currency markets. As a result, investors can count on earning that minimum return even if the rate of inflation were to remain high for decades.

While inflation bonds are viewed as one workable strategy for creating a nest egg for the retirement years, financial professionals usually do not recommend this investment as the foundation for a retirement plan. The greatest benefit is achieved when the bonds are viewed as a means of generating returns that augment the benefits created with other retirement schemes, including pension plans, Individual Retirement Accounts, and 401(k) accounts. For this reason, investors should not choose to rely solely on returns from inflation bonds, but see them as a way to provide additional financial security for the retirement years.

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