For investors inflation is the biggest risk, majorly for those investors who depend on fixed income. It means continuous increase in price of goods and services over the period. The purchasing power of money decrease as inflation increases. It means in future you buy fewer goods from same amount of money. Investors fail to protect themselves from this silent loss in many investments like fixed deposits and normal bonds.  In this context, Inflation-Protected Securities solve this problem. It is bonds that adjust their value according to inflation. As compare to other normal bonds where principal and interest remain fixed, these securities change with inflation. In Inflation-Protected Securities the principal value of the bond increases according to inflation and interest of this security is calculated on this increased principal. Investors are able to protect the real value of their money over time because of this structure. In short, these securities assure investors that investment grows at the same rate of inflation, so purchasing power remains stable.

Why Inflation Is a Serious Problem for Investors

The real returns from investments are slowly reduced by inflation. An investor may earn a return of 9% on a bond, but if inflation is 6%, the real return is only 3%. In some situation return can be negative if inflation is higher than the return. This change in investments is more problematic for long-term investors and retirees who rely on fixed income. Through Inflation Protected Securities investors reduce his risk by linking returns directly to inflation, beacsue these securities prioritizes more on real returns rather than nominal returns.

How Inflation-Protected Securities Function

The simple function of Inflation Protected Securities is to link the investor capital with Inflation Index. The Index could be Consumer Price Index (CPI) or Wholesale Price Index (WPI). It means as rate of inflation increases then the capital is also increased in similar proportion and payment for interest are calculate on adjusted principal amount. In short, both the principal and interest move in line with inflation. But in a situation where inflation fall the value of principal will also falls. However, the inflation rate rarely fall and in most government-issued inflation-protected bonds, investors receive at least the original principal at maturity, which provides an additional layer of safety.

Types of Inflation-Protected Securities

• Treasury Inflation-Protected Securities (TIPS)

Treasury Inflation-Protected Securities (TIPS) is one of the most well-known inflation-protected securities, which are issued by the U.S. government. TIPS are calculated on U.S. inflation data and pay interest on the adjusted principal. At maturity, TIPS give reliable hedge against inflation as investors receive the higher of the original or inflation-adjusted principal. Different countries, including India issued inflation-indexed bonds which linked to domestic inflation. These securities work in similar manner, although they are not issued frequently and are not very liquid in the secondary market. TIPS are also issued by many developed economies such as UK and European countries.

• Inflation-Indexed Government Bonds

To protect investors from rising domestic inflation governments issued Inflation-indexed government bonds. These bonds are linked to the country’s inflation index like CPI &WPI. It helps investors in preserving purchasing power because both principal and interest payments adjust according to inflation. In India these bonds are no t regularly issued but it has issued in past, that’s why these bonds have low liquidity in market and come with less credit risk.

• Inflation-Protected Mutual Funds and ETFs

These types of securities are invested in a portfolio of inflation-linked bonds such as TIPS and global inflation-indexed securities. It provides a better way for retail investors to gain inflation protection without buying individual bonds. Better diversification, liquidity and professional management are offer by these funds. However, returns on these funds may differ because of change in interest rates and fund expenses. It will more meaning full for investors who wants convenience and long-term inflation protection.

• Pension-Linked Inflation Products

Pension-linked inflation products are long-term instruments made for specifically retirees and pension funds. It helps to protect investors by payouts increase with inflation and rising living costs over time. It often involves long lock-in periods but provide stability and predictable income. As they giving strong protection against inflation that’s why returns are not very high. These are perfect for long-term retirement planning and income security.

• Corporate Inflation-Linked Bonds

Corporate inflation-linked bonds are issued by companies and offer returns linked to inflation. These bonds aim to protect investors from rising prices while offering higher returns than government bonds. However, they carry higher credit risk because repayment depends on the company’s financial strength. Such bonds are less common and require careful credit analysis. They are suitable for investors willing to take moderate risk for better inflation-adjusted returns

Advantages of Inflation-Protected Securities

The protection against the inflation is the biggest advantage of Inflation-Protected Securities. Over the period, these securities help investors to maintain the real value of their money. In a volatile market situation, Inflation-Protected Securities provide stable real returns, and it is significant during periods of high or unpredictable inflation. Secondly, major benefit of these securities is safety because majority Inflation-Protected Securities is issued by governments, which means they carry low credit risk. Another key advantage is diversifying an investment portfolio because their performance is influenced more by inflation trends than by stock market movements.

Disadvantages of Inflation-Protected Securities

Inflation-Protected Securities also have some limitations, despite having some benefits. The major drawback is Inflation-Protected Securities offer lower interest rates compared to normal bonds because they focus on to beat inflation. But if inflation remain low for a period then these securities provide lower return, as traditional bonds may generate better returns. Another limitation of these securities is taxation, because in some countries the appreciation of principal amount is taxable even though the returns is not immediately receive by investor which will result in reduction in post tax income, mainly for investors who fall in higher tax brackets.

Conclusion

Inflation-Protected Securities play a very important role in protecting wealth that’s why they may not offer high or exciting returns. With the help of right investment tools we can reduce impact of inflation on our investment. Inflation-Protected Securities help investors to achieve stable returns, maintain purchasing power and reduce long-term inflation risk. Inflation-Protected Securities provide stability and predictability by focusing on real returns instead of nominal returns. It reduce the risk of that inflation will erode savings over time. Although, they may not generate high growth but help in hedge against inflation and play a crucial role in building a balanced and resilient investment portfolio.