Why TIPS Could Be Trouble

Where's your cash?

What do you mean, where's my cash? It's in my wallet. Unless those kids took it again.

Not that cash. I mean, where are your savings? CDs? Money market fund? Bank account?

It certainly isn't in my mattress, smart guy. I've got some CDs, and some of those TIPS -- the Treasury bonds that adjust with the inflation rate.

Inflation protection is definitely a good thing to have. But there's a problem with TIPS --

Is this the part where you go on and on about "fiat money," and tell me that hyperinflation is just around the corner? And that I should put all my money in gold and have it delivered to the house?

No, that's some other guy. I don't think we're going the Zimbabwe route.

Good, because I'd make you carry all that gold down my basement stairs. You know those little gold bars you see on TV weigh, like, 30 pounds each, right?

I don't think you need to be stashing gold in the basement. But I do think that we could get a period of 1979-style inflation before this mess is over. And TIPS might not be the best way to --

So what, a year of 10%? Well, from what I've learned reading your column over the years, my stocks should keep pace with it. Commodities stocks are a good inflation hedge, don't you think? I've got ExxonMobil (NYSE: XOM  ) for oil, BHP Billiton (NYSE: BHP  ) for aluminum and coal, Kellogg (NYSE: K  ) for cookies ...

Cookies?

Yeah, Kellogg owns Keebler.

Dude, Deluxe Grahams aren't a commodity.

You don't think so? I think that in a nation of 300 million people stressing about the economy, cookies are totally a commodity, or at least something worth betting on. I should get me some PepsiCo (NYSE: PEP  ) too -- they own Frito-Lay. Mmm, Fritos. 

Y'know, Fritos might actually be a decent inflation hedge. But I was talking about TIPS. It turns out that there are some big issues with --

And that supermarket stuff is good to be holding right now, even if we don't get any inflation. People don't want to cut out Fritos after they've been laid off, you know? I've been looking at Kimberly-Clark (NYSE: KMB  ) . Same deal there -- Kleenex and toilet paper, and a nice dividend.

It's nice to see someone's been reading my articles. Sure, dividends are great right now. But like I was saying, there are some problems with --

I got some small-caps for growth, too. Like Green Mountain Coffee Roasters (Nasdaq: GMCR  ) -- all those job hunters staying home and drinking coffee from their Keurig machines instead of going to Starbucks. You know Green Mountain gets 6.4 cents in royalties on every one of those K-cups? That's not counting the ones they make themselves. They just signed a distribution thing with Wal-Mart (NYSE: WMT  ) , they're going to sell zillions of those little --

­-- TIPS that most people don't know about. Listen to me for a minute. We need to talk about your cash, not stocks.

I know I need diversification, but saving cash is boring. I've got CDs. I roll them over every few months. If inflation goes up, the Fed will crank up interest rates just like last time. I'll keep up.

That's a good idea. But --

I also got a bunch of those TIPS things just in case I get lazy with the CDs. Bought 'em from that Treasury website. Easiest thing in the world to do. I don't know why you think there's anything wrong with them.

That's what I've been trying to tell you. It turns out that TIPS have some drawbacks. I used to like TIPS a lot. But I was just reading something that made me think twice about them.

Really?

Yeah. It was an article by Robert Brokamp in the new issue of Rule Your Retirement. It just came out today. You know how TIPS adjust the principal every year to keep pace with inflation?

Yeah, that's the whole point of buying them.

Did you know that those adjustments are taxable in the year they're made, even if you don't sell the bond?

What? That's crazy!

Crazy or not, it's true. If you hold TIPS, you should hold them in your IRA.

But Treasury Direct doesn't let me hold them in an IRA. That's a big problem.

Yeah, maybe so. But there's another problem with them, a bigger one. It has to do with the way TIPS adjust for inflation.

Inflation is what it is, right? What's the problem?

The short answer is that the methodology the government uses may understate inflation when push comes to shove, and that could cost you big bucks.

Wait, what's wrong with their methodology?

I'd explain, but you used up too much of my article talking about cookies. I'm almost out of space. Go check out the new issue of Rule Your Retirement for the full scoop. It's the "Wealth Defense" article on page 4 -- explains the whole thing.

Don't I need a subscription for that?

Nope. Just grab a free trial and you're good. Full access for 30 days with no weird catch. And don't wait, you'll forget about it -- click here to get rolling right now.