Follow Comments Following Comments Unfollow Comments

These funds own Treasury Inflation Protected Securities—Treasury bonds and notes whose principal and coupon payments step up with the cost of living.

That just about eliminates inflation risk. It doesn’t eliminate risk, as is quite evident from what happened in 2013 to TIP. the iShares TIPS Bond ETF. The $13 billion fund made its holders 8.7% poorer. What happened? Interest rates on Treasurys went up, but inflation expectations did not go up.

That meant real rates went up. When real rates go up, the price of a real rate bond goes down.

The iShares portfolio has a weighted average duration of 7.6 years, Morningstar reports. You’d buy it rather than a fund owning non-inflation-adjusted bonds if you either think that inflation will race well ahead of 2% or want to lose no sleep over the possibility.

What’s the expected return from a fund that owns 7-year TIPS? You’ll see two yield numbers for TIP. One figure, the payout rate, is 1%; this is tied to the taxable income from the fund. The other, the so-called “SEC yield,” involves an even more abstruse calculation and comes out as 5.7%.

Neither one of these yields really tells you what is going on. A better number can be derived from an interest rate series published by the U.S. Treasury. It reveals that the real yield to maturity on TIPS due in 7 years is 0.3%. From that, subtract the fund’s 0.2% expense burden. That leaves you with a 0.1% real annual return.

That doesn’t mean you are necessarily going to earn 0.1% above inflation. It means that 0.1% is the average of all the possible dice rolls that describe what will happen in the bond market.

On our list of cost-efficient ETFs there are only three other inflation-linked funds with $1 billion or more. Vanguard Inflation-Protected Securities (VTIP ) has a duration of 2.4 years and an expected real return that I estimate at -0.4%. The Pimco 1-5 Year U.S. Tips fund (STPZ ) has a duration of 2.5 years and an expected real return of -0.5%. FlexShares iBoxx 3Yr Target Duration TIPS (TDTT ) has a duration of 3 years and an expected real return of 0.4%

Our cost figures show the cumulative portfolio cost over ten years on an investment that starts out at $10,000 and grows 5% a year. They reflect bid/ask spreads, the expense ratio and, in rare cases, income from securities lending. For comparison with stock funds they assume the same 5% annual return over the decade, even though these funds will almost certainly earn less than that.

This file contains the rules and methods for the ETF ratings and a directory of the separate ETF ranking groups. Duration is explained in the survey of medium-term bond ETFs .