Inflation and interest rates are destined to change in the coming months, perhaps radically. These potential changes present significant risks to baby boomer investors. A CD ladder is often used as a safe way to control interest rate risk. A ladder of Treasury Inflation Protected Securities (TIPS) can provide both interest rate and inflation protection.
It is very easy to build a short or medium term ladder using conventional Treasury Bills. It is not so easy to do this with TIPS because they are sold at auction with maturities of 5, 10, or 20 years. For a ladder, you want a shorter period between steps.
Thus, if you wanted to create a three-year Treasury Ladder (maturing at 1, 2, and 3 years) today using TIPS, you would need to buy at least some of the TIPS in the secondary market. You can do this through a broker but you must be very careful about the pricing and fees involved. However, once you set up the initial ladder, you can replace TIPS in your ladder that mature by purchasing them directly from the government at auction. You can learn how to do this by visiting Treasury Direct.
There is another way of creating something that is similar to a Treasury ladder of TIPS. You do that by purchasing shares of multiple mutual funds and/or exchange traded funds that invest in Treasury Bonds and TIPS having different maturities. For example, you can buy the iShares Barclays Short Treasury Bond ETF (SHV)), the iShares Barclays 1-3 year Treasury Bond ETF (SHY), and the iShares Barclays TIPS ETF (TIP). The latter fund has a weighted average maturity of 8.65 years so this strategy is not optimal but it is easy to do compared to buying TIPS in the secondary market.
You can monitor rates and yields for TIPS at Bloomberg.com. Definitely check those numbers out before making a decision about laddering Treasuries as compared to a CD ladder.
Also, if you do buy TIPS, consider holding them in a tax-deferred account so that the virtual income (inflation adjustments) doesn’t increase your current tax burden.
Finally, keep in mind that CD and Treasury ladders are very conservative investments. They can work great for your retirement emergency fund but may not be best for your long term retirement portfolio. To further consider that issue, run your current investments through a portfolio analyzer tool.
If you are interested in the general subject of laddering as a strategy for lowering risk, don’t overlook laddering of annuities.
Update 1: Pimco has introduced several new exchange traded funds (ETFs) that own TIPS having different maturity levels. These could be used to build an inflation protected Treasury Ladder using funds instead of individual bonds.
Image credit: Sergio Roberto