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VIPSX says it has returns of >= 5% over 5 years and almost 9% in the last year. It appears to be based on U.S. inflation-protected securities. However, U.S. treasuries are returning near zero, and inflation is near zero.

Explain.

P.S. This answer recommends inflation-protected securities, so I'm curious.

  • Perhaps they're lying ... ;) – Matthew Read Dec 15 '10 at 1:24
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Without having researched that particular fund, I believe that they bought bonds in the past, say five years ago, interest rates were higher. As the interest rates have dropped, those bonds became more valuable, so their price rose. As a result what you are seeing is not just the direct interest rate that bonds have, but also the boost that bonds get when interest rates fall. Of course, in the future, if interest rates should rise, then you'll see the opposite effect where bond funds will deliver lower returns.

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    It's an inflation-protected bond, not inflation-protected cash. They can still return real interest and fluctuate in value. Buying TIPs is basically the same as buying a regular Treasury bond and then buying some inflation insurance for that amount (except with less risk that the guy selling you the inflation insurance will go out of business - counterparty risk). – user296 Dec 16 '10 at 19:04
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Knox's answer is correct, but I wanted to elaborate a bit.

The price for an individual bond increases as interest rates decrease.

If you buy a bond that pays 5% at par (100), and next year a similar bond yields 3%, people will pay a premium if you sell the 5% bond (which varies based on a number of factors, but the bond would sell at a rate greater than 100), since you are yielding a higher interest rate. Conversely, if rates go up, that 5% bond will sell at a discounted rate (less than 100).

With VIPSX (the Vanguard TIPS fund you referenced), the fund's portfolio page has alot of useful information, including a listing of the specific bonds in the portfolio.

TIPS bonds are also a little unusual, because the inflation protection gets added to the principal -- so even if there isn't any inflation, the bonds prices will still fluctuate as rates rise and fall.

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