Playbook #070: Treasury Inflation-Protected Securities (TIPS)
🖼️ The Big Picture
In this high inflation environment, TIPS (Treasury Inflation-Protected Securities) have been generating some excitement among investors. Or at least, as much excitement as government bonds can.
They’re similar to U.S Treasury Bonds, which are considered the gold standard for conservative fixed-income investors. To date, the U.S government has never failed to pay investors back on these low-risk bonds, and as a result, they pay measly yields.
Investors who like this kind of security in a chaotic world have been buying TIPS because they adjust the principal value of the bond for inflation in order to preserve their real-world value.
Interest rates on these bonds, however, stay the exact same as when they were issued.
So, when inflation goes up… the principal value of your TIPS goes up.
When there’s deflation… the value goes down. However, your principal amount is guaranteed, so you can never lose money with TIPS.
New TIPS are issued at the end of every month in an increment of either 5 years, 10 years, or 30 years. They pay interest every 6 months… and the 10-year bond recently jumped from only 0.125% up to 0.625%, which is a result of the Fed raising the prime rate.
Here’s how it works: If you have a $1,000 bond and inflation rises 9% based on the CPI, the value of your bond increases to $1,090… and you’re paid your 0.625% interest on the updated value.
There’s a small tax kink with this, in that increases in the TIPS principal value for inflation are considered income and have to be reported on your tax return… even though you haven’t realized that gain (and won’t until you sell or the bond matures).
You can hold them until maturity. Or sell them on the highly liquid open market before maturation. However, if the principal value is less than when you bought it (during deflation), you may have a hard time unloading your TIPS.
TIPS can be bought through a mutual fund or ETF, but many prefer to buy directly from the government (Treasury Direct) to avoid any management fees.