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TIPS for Investors? (PART III)

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In Parts I and II, we surveyed the history, design, and performance of TIPS fixed income securities. As we suggested there, thousands of TIPS investors questioned their allocation to TIPS during 2013 – when the total return of the iShares TIPS Bond ETF (TIP) [a $12.5 billion AUM ETF] was a negative 8.65% -- deeply under performing the mainline U.S. bond index funds!

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I had the opportunity to solicit insights regarding the TIPS asset class from a 21-year veteran financial advisor at Merrill Lynch: Shankar Iyer, CFP. Referring back to the details outlined in Parts I and II, I asked Mr. Iyer:

“In the fixed income space, many advisers have cautioned against TIPS because "there are no signs of inflation." As with most fixed income instruments during 2013 and 2014, TIPS have not been viewed as the best investment option. What are your thoughts on TIPS and allocating money to that asset class?”

Here is Mr. Iyer’s response:

“Thanks for asking to dialogiue with me, Tom. Treasury Inflation Protected Securities, or TIPS, shield investors from most, if not all, of the risk of erosion of income and principal value caused by inflation, which is usually the major risk involved in holding a high-quality bond.

“As you pointed out in the earlier articles, the principal value of TIPs moves proportionately with the Consumer Price Index (CPI). In the event of deflation, the principal value could fall below par (ie. the “face value” of a bond). However, when held to maturity, an investor is assured of getting at least that initial par value! The actual yield one receives from a TIP bond will include the interest paid, plus a year-end inflation adjustment. In fact, that inflation component is the key feature of a TIP. Because of that “extra feature”, the market price of a TIP bond will vary with both market expectations about inflation and current interest rate levels.”

TOM: “I agree, Shankar! Conceptually, the design of TIPS is both intriguing and appealing. That ‘appeal’ actually drew no less of an expert than the distinguished university professor, Dr. Zvi Bodie, to suggest in 2009 (during the chaotic anxiety of the Financial Crisis) that investors should put 100% of their retirement assets into TIPS.

“Of course, TIPS have since proven that to have been a strategy with very disappointing results. But more to the point – even when we were children growing up, our parents taught us to ‘never put all of your eggs into one basket!’ Having an overly concentrated portfolio is never a good idea!”

IYER: “That’s a great point, Tom. Sound asset allocation (diversification) is one of the foundations upon which financial planning is built. No one would have wanted to be invested solely in TIPS during 2013! However, despite the underperformance and volatility of TIPS in recent years, we should not abandon them as a potential part of our portfolio! Elaborating upon that point, Merrill Lynch research (including the December Research Investment Committee Report) experts believe that there is definitely a place in most investors’ portfolios for TIP bonds.

As the Year-to-Date return from TIPS has demonstrated (see Slide 1) -- having a portion of one’s bond portfolio that is protected against an unexpected upward move in inflation can go a long way towards enhancing portfolio diversification and lowering risk. This is a significant positive for TIPS holders.

Therefore, the question we should ask is not whether to own TIPS at all, but rather how much of one’s assets to allocate to TIPS! That allocation decision should be determined in conjunction with a trusted investment advisor that has a full understanding of your long-term goals and objectives, and is aware of your comfort with risk.”

TOM: “Thank you, Shankar! I appreciate your time.”

Mr. Iyer serves Merrill Lynch as a Senior Vice President and is available to clients as a Wealth Management Advisor. His specialties include investment strategies, goal-based planning, and wealth transfers. If you would like to contact Mr. Iyer, you may reach him at 312- 269- 5166. In addition, if you want to access a solid source for education regarding investments, consider looking at this site: http://learning.merrilledge.com/?category=MLFLC-IE&subcategory=MLFLC-IB&content=202

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