The US Department of the Treasury has been offering a specific type of bond that can help protect consumers against inflation for several years now. Called TIPS, the acronym stands for Treasury Inflation Protected Securities and includes bonds issued with maturities of 5, 10 and 30 years.
All three of these TIPS bonds can shelter you from inflation due to the fact that they are adjusted semiannually based on the Consumer Price Index-Urban Consumers (CPI-U), one of the most widely used measures for inflation and one which is used to calculate interest payments on an inflation-adjusted principal.
If inflation happens to occur throughout the life of the bond (which is probable) the interest payments will increase and, at maturity, you will receive the greater value if the adjusted principal is greater than the face or par value of the bond.
If that sounds like a good idea, and it should, the answers below to the most common questions about all TIPS will help you to determine your next move. Enjoy.
First, TIPS are issued by the federal government and thus are backed by their “full faith and credit” guarantee. You can purchase them for as low as $100 and you will get interest paid to you twice a year. That interest is subject to federal income tax however, but not state or local taxes.
You can purchase TIPS quite easily through the US treasury at TreasuryDirect. They are sold in single price options and everyone gets the same price, equal to the highest accepted yield at that particular option. On the U.S. Treasury’s website you will find their Tentative Option Schedule and also their Offering Announcement, so that you will know when the next TIPS auction will occur. You can also purchase them through a broker or financial institution but, as prices vary from one to the other, your best bet is to take some time and shop around.
One of the best reasons to purchase TIPS is that, even if there is a negative inflation rate or deflation, your TIP investment will never be worth less than what you paid for it as long as you paid more than the face value and didn’t sell it before it matured. The reason is that the Treasury Department is agreeing to pay, upon maturity, the initial face value of the bond or, if inflation has occurred, the inflation-adjusted face value, whichever is the greater of the two.
One trade-off that you must keep in mind if you consider purchasing TIPS is that the interest rate is probably going to be lower than other types of Treasuries that have similar maturities. The fact is, when inflation happens to be low, the possibility of getting better returns from other Treasury securities will be higher.
Finally, if you wish to sell your TIPS before they mature you can because they are what’s considered a liquid asset. You can buy and sell them on the secondary market before maturity, but your price will be subject to any market valuations at the time, which may result in either a capital gain or loss.
Hopefully any questions you have about TIPS have now been answered. If you happen to have more however, please drop us a line or leave a comment and we’ll be sure to get back to you with an answer ASAP.