If you’re worried about inflation and worried about traditional inflation-busting investments (the stock market, since inflation risk should be priced into the market price of shares), you might want to give Treasury Inflation-Protected Securities, or TIPS, a look. TIPS are simply treasury bonds that make adjustments because of the rate of inflation. The coupon rate of the bond remains the same but the principal is adjusted along with the Consumer Price Index, so you get protection against inflation.
Let’s use an example of how a TIPS would work to help illustrate them. Let’s assume you purchase a $1,000 TIPS bond with a coupon rate of 3%, it’ll pay out 3% interest each year. If inflation came in at a screaming 10% (screaming now, but quite pedestrian compared to the 80s), the principal of the bond increases by 10% to $1,100. The 3% coupon is then calculated using the $1,100 value and not the original $1,000 value.
What happens with a regular bond? That adjustment of the principal or face value of the bond doesn’t occur, so you would only get 3% on the original $1,000.
The difference now is that you won’t be able to buy the two bonds at the same price, the nominal bond should be cheaper because you are assuming the interest rate risk rather than the government.
So, if you’re on fixed income and concerned about inflation, consider TIPS. For more information, visit this Treasury website discussing TIPS.