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Inflation Protected Bonds

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Inflation plays an important role in investing. During times of high inflation, inflation ETFs become interesting. What is behind these ETFs, what inflation-protected bond ETFs are and when the investment is worthwhile is presented in this article.

Inflation is on the rise

Due to the Corona crisis and the associated stock market crash, the monetary policy of the ECB and also the Federal Reserve in the US was loosened significantly. As a result, enormous sums of money were printed.

Let's take the world's most important currency as an example - the American US dollar. In the strong crisis months from February to May 2020, approximately 2.57 trillion US dollars were printed (in English: 2.57 trillion USD). In the same period in 2019, only 0.19 trillion US dollars were printed. That's an increase of 1,252.63% - the last time there was such an increase was in 1943.

What is the expected inflation rate?

More money in circulation means that the strength of a currency decreases in https://exnesslatam.com/cuenta-pro/ and leads to a loss of purchasing power. An inflation rate of 1-2% per year has been considered adequate to drive the economy in recent years. An inflation rate of around 4.98% is expected for the US in 2021. As of December 2021, US inflation is 6.8% year-over-year. Inflation results in a sharp loss of purchasing power. At the current rate of inflation in the USA, 100 US dollars will only be worth 93.2 US dollars at the end of the year.

Expected euro inflation in the euro zone

In Europe, the European Central Bank expects an inflation rate of 2% for the euro in 2021. As of November 2021, inflation was around 4.9% year-on-year. Inflation causes a loss of purchasing power. With the current inflation of the euro, 100 euros will only be worth 95.1 euros at the end of the year.

How can I react to inflation as an investor?

If you invest your money in broadly diversified ETFs, as I do in my ETF savings plan comparison, you may have noticed that an MSCI World equity ETF, for example, can be subject to high fluctuations.

In order to compensate for high fluctuations and to minimise the so-called maximum drawdown (highest price loss of a financial instrument), bonds or bond ETFs are often used as a hedge.

If the inflation rate is high, bonds are less attractive because the interest rate of the bond is not adjusted to inflation. This is where so-called inflation-linked bonds (also known as inflation-indexed bonds or inflation-linked bonds) become interesting.

What are inflation-linked bonds ETF?

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With an inflation-linked bond, the interest rate is linked to the consumer index. The interest rate on the bond is thus flexible and not tied to a fixed value as is normally the case.

Roughly speaking, the value of the inflation-linked bond rises when inflation rises. The value falls when inflation falls.

An inflation-linked bond ETF often tracks indices with different inflation-linked government bonds, so you are invested in individual countries or regions at the same time.

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