INFLATION PROTECTED SECURITIES (OR TIPS) ARE ONE WAY TO HOLD BONDS WITH SOME PROTECTION AGAINST INFLATION -- THEY'RE ALSO THE STRONGEST BOND CATEGORY

TIPS ARE INFLATION PROTECTED BONDS... With all the talk about protecting oneself against rising inflation pressures resulting from higher commodities and a falling dollar, it's worth considering Inflation Protected Securities (or TIPS). These are Treasury bonds that are indexed to the rate of inflation as measured by the Consumer Price Index (CPI). In other words, the principal paid on TIPS goes up if the rate of inflation rises. This is one way to keep some of one's money in bonds (for diversification purposes) while also having some inflation protection. Fortunately, there's an Exchange Traded Fund that allows you to do that. In fact, there are ETFs for several bond categories. Three of them are shown below for comparison purposes. Chart 1 plots the iShares Lehman TIPS Bond Fund (TIP) which is the strongest of the three categories. Charts 2 and 3 show Corporate Bond Fund iShares (LQD) and the 7-10 Year Treasury Bond iShares (IEF). Treasuries have been the weakest of the three. All three fell sharply during the spring and started to rise near mid-year.

Chart 1

Chart 2

Chart 3

TIPS HIT EIGHT-MONTH HIGH... The same three charts are shown below, but with a shorter time perspective. Chart 4 shows the TIP iShares reaching the highest level in eight months. It's clearly the strongest of the three. Chart 5 shows Corporate Bond iShares in the middle of a trading range, but trying to move back over its 50-day average. Corporates usually do better than Treasuries -- especially with the strong stock market that we've had since August. Corporate bonds pay higher yields than Treasuries. Chart 6 shows the 7-10 Treasury Bond iShares trying to find support just above their 200-day average and chart support along the September/ October lows. Not surprisingly, Treasuries have the lowest yields of the three categories. That's because Treasuries also carry the lowest risk.

Chart 4

Chart 5

Chart 6

2004 COMPARISONS FAVOR TIPS... Year-to-date comparisons of the three bond categories confirm the relative strength of the TIPS. Of the three ETFs shown here, TIPS have been the strongest during 2004 with a gain of 4%. Corporates came in second with a 2004 gain of 1.2%. Seven-ten year Treasuries came in third with a gain of .78%. It's always a good idea to keep a portions of one assets in bonds. How much depends on one's outlook for inflation, the economy, and the stock market. A falling dollar, however, combined with rising gold and oil prices, suggest that inflation pressures should start to build. In time, that should take a toll on bond prices. One way to have to the best of both worlds is by holding some Treasury Inflation Protected Securities or TIPS. The fact that TIPS are the top performing bond category suggests that investors have already figured that out.