Worried about inflation in the future? Consider TIPS

— -- Current investment wisdom holds that the four horsemen of the apocalypse — pestilence, war, famine and Keanu Reeves — will soon be joined by a fifth rider: inflation.

And, in fact, that's a pretty good argument, given the vast amounts of money being thrown by the government at our financial woes. For that reason, you should be thinking about investing in Treasury Inflation-Protected Securities, or TIPS. But you have plenty of time to mull this one over, so there's no need to rush.

Inflation is a period of rising prices. By and large, we've lived with modest inflation ever since the mid-1980s. The government's consumer price index has risen an average 2.8% annually the past 20 years.

Even modest annual increases in prices, however, erode the value of your money over time. Let's say your sister Sarah got a $1,000 bond on her birthday that pays $50 a year for 30 years. But after 30 years of 2.8% inflation, Sarah's $50 payment would have the purchasing power of $21 now. If you want your money to maintain its buying power, you have to beat inflation.

Economists argue about what causes inflation. Generally, though, inflation is a product of too much demand for goods and services. For example, suppose you buy an artificial moose head and put it on the mantel. Your neighbor admires it and goes out and does the same thing. Pretty soon, everyone wants one, and the price of artificial moose heads soars, because Amalgamated Moose Head, the sole U.S. manufacturer, can't keep up with demand.

This whole example, however, assumes that people have enough extra cash to buy things like artificial moose heads, and at steadily rising prices. In short, inflation occurs when the economy is booming and when the supply of money is plentiful.

A plentiful supply of money tends to make the economy boom, which is where the argument for future inflation comes in. The Federal Reserve, which tends to the nation's money supply, has pushed down its short-term fed funds rate to somewhere between zero and 0.25%. In other words, money is cheap. Furthermore, Congress is considering a massive stimulus package funded with enormous amounts of borrowed money.

The actions of the Fed and Congress are designed to prevent deflation — a period of declining prices and slowing economic activity. Should the huge jolts of economic stimulus be too much, inflation is a distinct possibility.

The one problem with this argument: There isn't a single sign of inflation. Not one. Not anywhere. Stock prices have fallen more than 40% the past 12 months. Real estate prices are down. Unemployment is up, and fear of future layoffs has paralyzed the consumer. Just this week, Costco, the warehouse discount giant, announced it would cut prices and keep a lid on any future price increases.

What about all the economic stimulus? "There's overcapacity in every industry in every country," says Richard Bernstein, chief economist for Banc of America Securities-Merrill Lynch. "That's not going away in two days."

In fact, economic stimulus can take years to take full effect. "Given the immediate situation, where deflationary forces are prevalent, it could be a couple of years before we see any kind of significant pickup in inflation," says Tony Coffey, manager of Franklin Real Return fund.

So if you're worried about inflation, you may have plenty of time to fret. In the meantime, you can prepare yourself — and one reasonable step is an investment in TIPS.

Like all Treasury securities, TIPS are long-term IOUs issued by the federal government. Like Treasury notes and bonds, TIPS make regular interest payments. Unlike T-notes and T-bonds, however, your principal rises and falls according to changes in the government's consumer price index.

If the CPI rises and your bond's principal increases, you earn your fixed interest rate on a higher amount of principal, and therefore get a larger interest payment. If the CPI falls, your principal falls and you get a smaller interest payment. At maturity, however, you'll get at least the full value of the bond's principal at issue.

The CPI, incidentally, includes the volatile food and energy components, so if energy prices soar, your TIPS will rise in value, too.

Currently, a five-year TIPS is priced to reflect zero inflation for the next five years, says Mihir Worah, manager of Pimco Real Return. A 10-year TIPS reflects a 1% inflation rate for the next decade. Should the inflation rate rise back to post-credit-crisis levels — 2% to 3% — TIPS investors should do well.

You can buy TIPS directly through the TreasuryDirect program (www.treasurydirect.gov). Or you can invest in a TIPS fund. But you don't need to gallop to invest in TIPS. The inflation horseman is still comfortably far off.

John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. His new book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com.