Treasury Inflation-Protected Securities (TIPS) is a type of Treasury securities that provides protection against inflation and real return. I don’t know if TIPS is the best bond to buy or not — I don’t think that is the right way to think anyway, e.g., it is better to have a good investment policy and asset allocation plan. But according to Larry Swedroe, academic literature strongly favors TIPS over other kinds of fixed income investment. Whatever the case may be, they are great adds to a well-diversified investment portfolio.
To provide inflation protection, the principal of a TIPS increases with inflation (and decreases with deflation) as measured by the Consumer Price Index (CPI). Like other Treasuries, TIPS pay interest at a fixed rate twice a year. The rate is applied to the adjusted principal, as such, the interest payments rise with inflation and fall with deflation. At the maturity, you receive the adjusted principal or the original principal, whichever is greater — protecting you against both inflation and deflation.
Let’s take a look at an example where you purchased a $1,000 in TIPS at 4.25% interest rate and the CPI rose 3%. First, the principal is adjusted for inflation, so your principal rises from $1,000 to $1,030, and increase of 3% as per the CPI. Then the interest payment would be calculated from the new principal. At the fixed interest rate of 4.25% and adjusted principal of $1,030, the amount of interest would be $43.78.
There are several advantages that make TIPS one of the best bonds to buy, these include:
Here are a few sites where you can find the most recent interest rates for Treasury securities:
Of course there are some disadvantages to consider, but overall I think TIPS is a very good fixed-income investment — especially for retirees who are most sensitive to inflation. There are a lot of good information on TIPS. If you are interested in more information, I highly recommend the TreasuryDirect TIPS Research Center. Larry also has a great section on inflation-protected securities in his new book: The Only Guide to Alternative Investments You’ll Ever Need.