(MONEY Magazine) – STRATEGIES

Here's a Tip: It's Time for TIPS

Investing in a bond fund may seem foolhardy today. After all, interest rates are climbing and inflation is heating up (as anyone who's been to a gas station lately knows). And when rates rise, bond prices fall. But bond pros spot an opportunity right now.

For fixed-income investors, Treasury Inflation-Protected Securities, or TIPS, are a good value. These issues automatically pay out more as the consumer price index (CPI) rises. Recently, 10-year Treasuries were yielding 4.2% while 10-year TIPS yielded 1.7%, not including the inflation adjustment, which is set twice a year based on the CPI. The CPI would have to climb just 2.5% for TIPS to match the 4.2% Treasury yield. But the CPI jumped at a 3.6% rate in August due to soaring energy prices. Says Dave MacEwen, head of fixed-income investing at American Century: "Given the likelihood of somewhat higher inflation, TIPS are more attractive than Treasuries right now."

TIPS offer another cushion--price protection. Demand for TIPS has grown while supply has been tight. The Treasury has issued $310 billion in inflation-protected bonds, which amounts to 1% of the U.S. bond market. Because professionals aim to keep a 5%-to-10% stake in TIPS, notes Kenneth Volpert, head of fixed-income investing at Vanguard, that scarcity gives TIPS price support.

You can buy TIPS at treasurydirect.gov; fund investors can use Vanguard Inflation-Protected Securities (VIPSX), a MONEY 50 fund. Because you are taxed on the rise in the bond's value, TIPS are best held in a tax-sheltered account.

WHAT'S WORKING

International funds are riding high. The top five are up more than 40% during the past 12 months.

NOTES AND SOURCES: Unless otherwise noted, data as of Sept. 22 from Lipper, New York; 877-955-4773. TIPS fund data as of Sept. 26. [1] Annualized. N.A.: Not applicable.