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Inflation may damper fixed-income assets by diminishing their buying power and reducing their actual returns over time. This occurs even when the inflation rate is modest. If your portfolio returns 9% and the inflation rate is 3%, your actual returns are around 6%.
Inflation-indexed bonds may assist to mitigate inflation risk since their value rises during inflationary times. Inflation-linked bonds are issued by the United States, India, Canada, and a number of other nations. Inflation-indexed bonds are a popular long-term planning investment tool for both individuals and institutions since they eliminate uncertainty.
Inflation-Linked Bonds: How Do They Work?
Inflation-linked bonds are connected to consumer goods prices as determined by an inflation index, such as the consumer price index (CPI). Each nation has its own way for estimating these expenditures on a consistent manner. Furthermore, each country has its own agency in charge of issuing inflation-linked bonds. As an example:
- In the United States, Treasury Inflation-Protected Securities (TIPS) and inflation-indexed savings bonds (I bonds) are marketed by the U.S. Treasury and are linked to the value of the U.S. CPI.
- In the United Kingdom, the Debt Management Office issues inflation-linked gilts that are connected to the country's retail price index (RPI).
- The Bank of Canada issues the country's real return bonds.
- The Reserve Bank of India (RBI) issues Indian inflation-indexed bonds.
For inflation-linked bonds, the outstanding principal normally grows with inflation.
As a result, when inflation occurs, the face or par value of the bond rises. In contrast, other forms of assets often lose value when inflation increases.
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