FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client owns a portfolio of blue-chip stocks and income-producing bonds. They are concerned about the erosion of purchasing power due to unexpected inflation. Which investment would be most suitable to address this specific concern?
- ATreasury Inflation-Protected Securities (TIPS)
- BCertificates of Deposit (CDs)
- CHigh-yield corporate bonds
- DGrowth mutual fund
Show answer & explanationAnswer & explanation
Correct answer: A. Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities (TIPS) are designed to provide protection against inflation. Their principal value adjusts with the Consumer Price Index (CPI), and the interest payments are then calculated on this adjusted principal, directly addressing the concern about erosion of purchasing power due.
Why the other options are wrong
- B. CDs offer fixed interest rates that may not keep pace with unexpected inflation, leading to a loss of purchasing power.
- C. High-yield corporate bonds offer higher income but carry significant credit risk and do not offer explicit inflation protection; inflation can erode their fixed payments.
- D. A growth mutual fund focuses on capital appreciation, not direct inflation protection, and may not provide consistent income.
Treasury Inflation-Protected Securities (TIPS)
U.S. Treasury bonds designed to protect investors from inflation by adjusting the principal value based on changes in the Consumer Price Index (CPI).
- Principal value adjusts semi-annually with inflation (CPI).
- Interest payments are fixed, but paid on the adjusted principal, so they increase with inflation.
- Provide income and protection against purchasing power erosion.
Memory trick: TIPS are the 'inflation shield' for your principal.