Mighty Bargain Hunter

Bogleheads Project Chapter 5

October 6th, 2006 | by mbhunter |

Welcome to Day 5 of the The Bogleheads’ Guide to Investing October project! Today’s post from the book deals with inflation-protected bonds.

Following the removal of the gold standard and the establishment of the fractional banking system the “silent thief” (p. 49) of inflation has eroded the purchasing power of the dollar. Cash loses value year after year.  The dollar has lost 96% of its purchasing power since 1913. A 2% savings account under 4% annual inflation loses 2% of real purchasing power each year.

Inflation-protected bonds aim to provide a positive real rate of return, effectively getting rid of the effects of inflation on purchasing power.

The two types of inflation-protected bonds discussed are I Bonds and treasury inflation-protected securities, or TIPS. Both bonds contain a fixed “real-return” component (usually in the neighborhood of one or two percent) and an inflation-pegged component based on measures of inflation for the period. So presumably the bonds’ returns are positive because they stay ahead of inflation by the real rate of return.

This is all warm and fuzzy — except that Uncle Sam takes his cut. The chapter also discusses the effect of taxes in different brackets.  All in all, it’s much better to be in a lower tax bracket when you cash in these bonds.  (It’s assumed that you’ll be in a lower tax bracket when you retire; I note that this is an assumption.)  If you do manage to lower your tax bracket, the likelihood of snagging a positive real rate of return is high.

I appreciated that The Bogleheads’ Guide to Investing had few good things to say about inflation.  Inflation-protected securities are one avenue to mitigate the erosion of inflation.  They’re not the only avenue, though.  Just being reminded that inflation exists is about half the battle.  A guaranteed 1% real rate of return from an inflation-protected bond is nice, but if you can find a 10% rate of return, even under 8% inflation your real rate of return is twice that of the bond.  So be sure to discuss with your financial planner other options in addition to I Bonds and TIPS if you’re interested in positive real rates of return.  (And who isn’t?)

I hope that you’ll continue to enjoy the upcoming commentary of The Bogleheads’ Guide to Investing for the rest of the month!  Thanks go to JLP for organizing this group book review, as well as to Wiley for the complimentary copy of the book!

Questions tagged credit-card at Cash Commons:

• Anybody have sucesss with 0% Balance Transfers on Credit Cards?
• When entering credit card information on a website, does the billing address have to be correct?
• Two of my credit cards got hit with fraudulent charges the same day. What gives?