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Inflation-Linked Bonds: 3 Things You Should Know

More specifically, a homeowner with a fixed-rate mortgage has a very predictable, very stable cost of housing. But the CPI-U includes changes in rental rates, and thus it can over- or understate the impact of inflation on a homeowner.

3. The breakeven rate is critically important

Inflation-linked bonds are just a small subset of the total bond market. It's an alternative to a traditional bond.

Calculating the breakeven rate is central to deciding whether or not an inflation-linked bond makes sense as an investment. Compare the yields on ordinary bonds to inflation-linked bonds to get a sense of the "breakeven" rate -- the inflation rate at which an inflation-linked bond will match the yield on an ordinary bond.

At the time of writing, Series I bonds paid a fixed rate of 0% plus inflation. A five-year U.S. Treasury note with no inflation protection paid 1.5%. Thus, inflation, as measured by CPI-U, needs to be higher than 1.5% for the Series I bond to provide a better return than an ordinary U.S. Treasury note.

Comparing the inflation-linked bond yield to a standard bond or note with a similar maturity date will give you a good way to gauge investors' expectations for inflation, and help you handicap whether or not an inflation-linked bond is a better place to keep your savings.

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The article Inflation-Linked Bonds: 3 Things You Should Know originally appeared on Fool.com.

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