Inflation protected bonds, or more specifically, Treasury inflation protected securities (TIPS) are Treasury bonds designed to protect against inflation. The principle of TIPS rises with inflation, and pays interest twice a year, at a fixed rate. In this article, industry experts discuss specific things investors should know about inflation protected bonds.
Best For Savings Not Investment
“Treasury inflation protected securities are meant to help protect your principal amount from the effects of inflation. Your invested amounts are adjusted regularly in accordance to changes in the consumer price index – the official inflation indicator in the country. And the inflation-adjusted principal amounts will be used to determine your possible interest earnings. Some important things to note about TIPS include:
It pays less than ordinary government securities: You can expect the interest rate for TIPS to be a few points below that of ordinary bills and bonds. But a TIPS holder stands to benefit in two ways; one is through regular principal amount adjustments in accordance with CPI changes and the second in form of the agreed interest.
Inflation is currently not an issue: TIPs is supposed to caution you against volatile changes in inflation like in the case of 2007/8 economic downturn when the purchasing power decreased by 3.84%.
The Treasury Direct account can be cumbersome: Unlike stocks, you can buy
TIPS directly from the government through a Treasury direct account. But I believe you are better off using a TIPS fund for two reasons. The managers are more experienced and therefore able to tell the best buys and also because it is more effective than using the sluggish Treasury Direct website.
Best for savings not investment: You are better off using TIPs for savings and not for investments because they post lower returns and are essentially designed to protect the principal amount from depreciating at the expense of earning solid incomes.”
Edith Muthoni, Chief Editor, Leanbonds.com
The Current Fed Policy On Interest Rates
“There is no doubt of an accelerating attraction to inflation-protected U.S. government bonds. The key to answering why this is occurring rests with the current Fed policy on interest rates. The facts are that the nominal and inflation-adjusted bond yields have dropped over the past 12 months (i.e., taking the 10-year U.S. government bond yields as an interest rate yardstick.) The economy is still chugging along in full-growth mode, thus exerting pressure on future yields and boosting bond prices still more. At the same time, the Fed’s go-to inflation gauge (measuring inflation over five years starting today) indicates an expected rate of just over 1.8%. We don’t expect the Fed to resume increasing interest rates until we see a small excess over the expectation. The scenario painted above points to inflation-protected bonds outperforming the categories with zero protection (i.e., nominal rate bonds). Even if reality overtakes expectations and the Fed pushes interest rates earlier than expected, inflation-protected bonds like TIPS (Treasury Inflation-Protected Securities) should continue to head the pack. The reasoning is that inflation will be back in play to spur the Fed’s change of direction, and therefore TIPS (indexed to the inflation rate) will continue to thrive. Either way, you are a winner in our view.”
Gordon Polovin, Finance Expert, Serves on the Advisory Board, Wealthy Living Today
These Types Of Investments Are Best Suited For Individuals Who Are In Or Approaching Retirement
“Treasury inflation protected bonds (TIPS) are designed to help investors protect against the effects of rising prices. These types of investments are best suited for individuals who are in or approaching retirement as they are a hedge against inflation and they provide the strongest bond hedge against default risk. TIPS also provide income in the form of coupon payments. These payments are generally paid semiannually and are based as a fixed percentage of the face value of the bond. The fixed-rate is applied to the principal, and like the interest payments, it can rise with inflation and fall with deflation. A couple of important things to note are that once TIPS mature, the investor will receive the greater of their original investment or the adjusted higher principal amount. Meaning the investor can’t lose money during a deflationary period. TIPS are best used in non-taxable accounts (Traditional or Roth IRA, etc.) because the increase in the bond’s value will cause a taxable event each year there is an increase.”
Jordan Sester, Founder/Investment Advisor Rep, J.S Financial Group
(Photo: Wikipedia)
You’re Better Off Owning Them In IRAs
“They’re not spectacular. Treasury inflation protected bonds TIPS are government bonds so there’s no default risk. The coupons are small. You run the risk of losing value if you sell prior to maturity. You will lose value in times of deflation. When the face value adjusts each year due to inflation it creates a taxable event. You’re better off owning them in IRAs where you won’t have to report taxes. They do hedge a risk.”
Chane Steiner, CEO, Crediful
Pay investors A Fixed Interest Rate As The Bond’s Par Value Adjusts With The Inflation Rate
“Treasury Inflation-Protected Securities (TIPS) are a form of U.S. Treasury bond designed to help investors hedge against inflation. These types of bonds are indexed to inflation, they have full faith and credit backing of the U.S. government. They pay investors a fixed interest rate as the bond’s par value adjusts with the inflation rate. TIPS pay interest at a rate that is fixed when the bond is purchased. Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. The actual coupon payment (the amount of interest you receive), then, will fluctuate every six months, because it is calculated based on the new inflation-adjusted full value of the bond for the following year. One has to consider whether the variable income is a factor that fits their lifestyle, goals, and needs before purchasing.”
Jimmy Masters, AIF(r) CRPS(r), Vice President-Investments, The Alcaraz Fisher Justis Wealth Management Group of Wells Fargo Advisors
Inflation protected bonds protect investors from the negative effects of rising prices. As with any investment vehicle, there are advantages and disadvantages to investing in Treasury inflation protected securities. If you are interested in TIPS, factor in what these industry experts have discussed, and remember to do your due diligence.
Sarah has been writing on the topics of politics, history and finance for over a decade. She is currently an editor at CPI Inflation Calculator, covering the topics of CPI, inflation, US economy and economic commentary.
