Inflation-indexed bonds

Inflation-indexed bonds

Although bond investing has changed from a world characterized by stability to one where price swings of 1 percent a day are common, there may be a chance for some stability to return to bond investors.

The US Treasury recently announced that it will issue inflation-indexed bonds. These types of bonds already have been issued in countries like Canada and England, but only recently in the United States.

At least initially, these bonds will be marketed mainly to individuals. It also is estimated that the total amount of inflation-indexed bonds issued by the US government will be less than 10 percent of the government's outstanding debt, so most bond investors will still face the threat of inflation.

Investors in inflation-indexed bonds will have to pay taxes on the increase in value of the bond due to inflation. Because of this, unless the bonds are placed in tax-deferred retirement accounts, an inflation-indexed bondholder may have to dip into his principal to pay the taxes due.

In spite of this, inflation-indexed bonds might be a good addition to traditional US Treasury bonds. Traditional bonds provide protection against deflation, while inflation-indexed bonds provide protection against inflation. Having both bonds in your fixed income portfolio should give you good diversification.