Last week, we discussed about how you can create a portfolio to moderate your inflation risk. As part of the discussion, we mentioned that you can consider investing in the US Treasury Inflation Protection Securities (TIPS). We received several queries from readers, wanting to know about investing in TIPS to meet their child's college education. In this article, we discuss why TIPS may be an attractive investment proposition and when such investment is appropriate for you.

TIPS adjusts your initial investment when inflation rises. That is, if you invest $10,000 in TIPS and consumer price inflation in the US moves up 2 per cent, your investment increases to $10,200 ($10,000 multiplied by 102 per cent). You are paid a fixed rate of interest on your investment every half year. The securities are offered in maturities of five, 10 and 30 years. A 10-year security, for instance, could have a real interest rate of about 2 per cent.

You should consider TIPS as part of your education portfolio only if you propose to educate your child in the US. Why else will you be concerned about inflation in the US?

We describe below two reasons why TIPS could be attractive. One, price levels in the US fell sharply after the sub-prime crisis. But inflation is likely to rise once the economy revives to the pre-crisis levels. Investing in TIPS will protect the purchasing power of your investments. Now, inflation on education is typically higher than the consumer price inflation. That said, TIPS does moderate the inflation risk on your education portfolio.

Two, TIPS is issued by the US Government. It is, hence, closest to credit risk-free investment. This means you can be confident that the Government will give you back your money when the security matures. But is TIPS appropriate for your education portfolio?

TIPS for you?

You should consider TIPS if you earn a part of your income in US dollars. Why? Your objective is to spend on your child's education in the US. You will not, therefore, run a currency risk if you earn in US dollars and invest in the same currency.

In any case, we want you to compare investing in Indian stocks and bonds with investing in TIPS to finance your child's proposed education in the US. If you choose to have a traditional education portfolio, you should invest significant proportion of your money in Indian stocks and some in Indian bonds, primarily bank fixed deposits maturing at the time your child enters college.

You are likely to face two issues on your traditional education portfolio. One, equity has high expected return but carries high risk as well. Should your equity investments in the education portfolio perform badly, you may be unable to finance your child's college education using only the portfolio redemption proceeds! And two, you may run a currency risk if the Indian rupee falls in value against the US dollar when your child enters college.

TIPS has its share of concern. As TIPS is taxable, you should make sizable investments through the years to ensure that you have enough accumulated money post-tax to fund your child's college education. You can invest in TIPS either directly or through mutual funds. You should seek appropriate investment advice if you plan to invest in TIPS.

Conclusion

TIPS can be part of your education portfolio, if you plan to send your child to the US for college education. We discussed the typical risks associated with TIPS and traditional portfolio. It would be optimal if you create an education portfolio that has a combination of Indian stocks and bonds and US TIPS; the higher expected return on Indian stocks and higher interest rate on Indian bonds could lower the investment capital required to meet your child's education expenses.

(The author is the founder of Navera Consulting, a firm that offers wealthmapping and investor-learning solutions. He can be reached at enhancek@gmail.com .)

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