Keep an eye on inflation when you invest

Like the boy who cried, “wolf,” experts’ warnings of inflation have been largely ignored over the last decade. Now, with the recent spike in fuel prices and rising interest rates, people are starting to take notice again. Inflation, even at modest levels, can seriously reduce real investment return. Is your portfolio structured to succeed in periods of inflation? Consider these fresh ways to combat an old foe.

• TIPS. A popular investment vehicle used to battle inflation has actually been around since 1997. Treasury Inflation Protected Securities (TIPS) are U.S. government bonds that adjust payout rates in accordance with rises in the Consumer Price Index (CPI). So if you have a low tolerance for risk, but seek protection from rising interest rates, this might be the bond for you.
  
• Corporate bonds. Another option is the inflation-indexed corporate bond. Patterned after the popular TIPS program, these bonds also offer rates that move in tandem with the CPI. The interest rates are higher than TIPS, but they carry the credit risk of the company that issues them.
  
• Tax issues. There are tax issues to consider as well. Inflation-indexed corporate bonds are fully taxable. TIPS, on the other hand, are exempt from state and local tax. Corporate bonds hold a slight edge in that interest rate increases are reflected immediately in the monthly payment. TIPS, instead, reflect rate increases in the principal balance received at maturity. What’s more, these increases are immediately taxable, even though you have to wait until redemption to reap the extra earnings. This timing difference could make TIPS better suited for your IRA or 401(k), where interest is not taxed until withdrawn.
  
• I bonds. If your portfolio is in a taxable account, you might consider I bonds instead of TIPS. I bonds are U.S. savings bonds with inflation protection. Like TIPS, I bonds are exempt from state and local income tax. But, unlike TIPS, federal income tax can be deferred until the bond is redeemed.
  
• CDs. Even an old standby, the bank certificate of deposit, is getting into the inflation protection game. Some banks now offer CDs with a fluctuating interest rate. Keep in mind that these investments are fully taxable, and they offer an initial interest rate that is lower than a conventional CD. But during periods of swelling interest rates, these CDs will return higher overall income.
  
• Laddering. Even if your bank does not offer flexible CDs, you can still protect yourself by laddering your CD portfolio with a range of maturity dates. Then, if interest rates climb dramatically, you won’t be tied up with one low-yielding certificate.
  
• Inflation can threaten your investment return at any time, so stay alert for ways to protect your portfolio.