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.
How Treasury Inflation-Protected Securities (TIPS) Work
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.
Key Benefits Of Treasury Inflation-Protected Securities (TIPS)
There are several advantages that make TIPS one of the best bonds to buy, these include:
- Inflation Protection — Since TIPS adjust for inflation, they protect investors from the risks of unexpected inflation.
- Real Return — Since interest rates are calculated after the principal is adjusted for inflation, investors are guaranteed a fixed rate of return regardless of inflation.
- Less Volatility — TIPS are less volatile than traditional Treasury bonds with similar maturity.
- Good Diversifier — Due to their low correlation to equities and other fixed-income investments, they reduce the overall volatility and risk of your portfolio.
- No Credit Risk — The chance that the government will default on bonds is virtually none — at least in theory.
- Tax Exemption — Like other Treasuries, TIPS are exempt from state and local taxes. However, interest payments and inflation adjustments that increase the principal are subject to federal tax in the year that they occur.
- Marketable — TIPS can be bought and sold in the secondary securities market. You do not have to hold TIPS to maturity.
- No Fee — You can buy TIPS at no fee through TreasuryDirect. However, there is a $45 fee if you wish to sell TIPS before the maturity date.
Where To Find The Latest Rates On Government Bonds
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.
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.