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We are selling our current property, and will be renting in the short term while looking for a property to purchase. We have some equity in the current property, so will get a payout at closing. To pick a round number, let's call this payout $100K.

We're not sure how long we will be renting, but it will likely be between 6 and 24 months. The goal is to hedge against inflation for the payout, as having that money lose value would be devastating to us financially.

My thought is that we would buy inflation protected treasuries (TIPS) and liquidate them when we purchase our next property.

My questions:

  1. How does one buy this quantity of TIPS? Do you simply buy directly from the US Treasury?
  2. Is it cheaper to buy a fund that invests in TIPS?
  3. Since bonds can go up in value (and are likely to with rates this low), is there a way to measure potential downside?
  4. Can I mitigate downside risk by choosing different TIPS maturity?
  5. Is there some other strategy I should be considering to protect my cash against inflation (or maybe a mixed strategy)?

Edit: I should have specified that I am not concerned about regular inflation--I want to hedge against the risk of hyper-inflation.

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    Be aware that TIPS not held to maturity (including TIPS in bond funds) may still be subject to interest-rate risk. If interest rates rise - which is, after all, supposed to be the canonical central-bank response to inflation - the price other people are willing to pay for the bond will fall, because they can get better interest rates from new bonds. – fennec Aug 13 '12 at 23:00
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How does one buy this quantity of TIPS? Do you simply buy directly from the US Treasury?

You will might have to go through a financial institution like a broker or a bank.
Edit: You can also buy bonds directly with TreasuryDirect.

Is it cheaper to buy a fund that invests in TIPS?

It might be cheaper depending on the fund itself. But you can't know for sure the price that the fund will be worth at you payout date.

Since bonds can go up in value (and are likely to with rates this low), is there a way to measure potential downside?

Statistically speaking yes. You can look at the variation in price/interest of the bonds in the last years, to see how they usually move, then compute the price range where they are likely to be (that can be wide for volatile securities). But there is no guarantee that there won't be some black swan event that will make the price shoot up/down. In another word, it's speculation

Can I mitigate downside risk by choosing different TIPS maturity?

There are quantitative strategies to do that, like finding that some products that are negatively correlated, such that a loss in one is be hedged by a gain in another. However those correlation are likely to be just statistics. And for every product that you buy you are likely to have to pay some fees for your bank/broker which can be more devastating than the inflation itself.

Is there some other strategy I should be considering to protect my cash against inflation (or maybe a mixed strategy)?

As I wrote above, trying to use complex financial products can incurs loss and will have fees (both for buying and selling). Is it really necessary to hedge from a 2% inflation by taking such risk? Personally, I don't think so. If I were you I would just be buying bonds maturing for your payout date. That would negate the reselling risk and reduce the fees.

  • Thanks for your answer. There have been predictions of hyper-inflation by some economists lately. I don't know how likely that really is, but hyper-inflation is more of a concern than regular inflation (I should have been more specific). – Phil Sandler Aug 13 '12 at 18:03
  • Is there a limitation (e.g. no more that $10K per month) in the TreasuryDirect program which is the reason that one has to go through a financial institution or bank? – Dilip Sarwate Aug 13 '12 at 22:08
  • @DilipSarwate You are right, you directly buy them through TreasuryDirect and the limits are about $5 millions/years for each maturity. I edited my answer to reflect that. Thank you for pointing it out ! – Mesop Aug 14 '12 at 7:19

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