Writing this article on Treasury Inflation-Protected Securities (TIPS) took me over a year because they are incredibly complex and tough to understand.
Over the last year, I have come to understand them more; however, I have yet to become an expert. I will direct you to others who have even more guidance about TIPS.
I want to give you a basic rundown of the advantages and disadvantages of TIPS so I can set the stage to compare them to other savings bonds, Treasury Bonds, and dividend stocks.
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Welcome back to the Investing for Interest series (101, 102, 103, 104, 105, 106, 107, 108, 109, 110, 111, 112, 113, 114), where we discuss everything involving interest income. Let’s begin.
What are Treasury Inflation-Protected Securities? TIPS are US Treasury Bonds that adjust their principal amount along with inflation.
The interest rate on the bond remains the same, and the principal will compound along with inflation.
Interestingly, you will not see the principal amount increase (or decrease) as it adjusts along with inflation (or deflation).
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That’s right; TIPS did have a negative inflation adjustment in 2009, alongside the Great Financial Crisis. This situation should be a rare occurrence, but it can happen.
Taking a look at the growth of the principal. Let’s look at how the principal can grow and compound along with inflation.
I will take an example from “The Bond Book,” which is the book that got me interested in these securities in the first place.
Let’s say we start with $10,000 in TIPS with a 3% annual interest rate. Let’s assume inflation stays at 2.5% for the 30-year TIPS.
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The magic of compounding. As you can see, the interest payments begin to add up over 30 years. We call this the magic of compounding.
Ideally, your principal will adjust at the rate of inflation, and your interest rate will ensure your money grows that much above inflation.
Instead of buying a 30-year Treasury Bond with a 4% interest rate, you could purchase a 30-year TIPS with a 2% interest rate.
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However, the TIPS (in theory) should guarantee you always remain 2% above inflation. The Treasury Bond would fall behind if inflation rises above 4%.
Buy and hold forever. As I said, the US Government created TIPS as a simple way for the average investor to beat inflation slightly.
However, selling your TIPS is highly complex because of how the market will price them. The price of your TIPS takes into account future inflation expectations as much as current rates.
With standard Treasuries, you can tell if you have a winning trade or not. If your bond interest rate is higher than current rates, the price of your bond increases.
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TIPS may be an entirely different story. Even worse, the price of TIPS sometimes moves differently than those of standard bonds. It’s a mess for the unassuming Average investor.
That’s why buying and holding your TIPS until maturity is best. I am a buy-and-hold investor, so this is an easy way to invest in TIPS for me.
Purchasing your first TIPS. I bought three TIPS so I could study them for this article. Buying TIPS is similar to purchasing other Treasuries.
Read my guide “How to Buy and Track 30-Year Bonds” for the particulars. Like other Treasuries, TIPS trade on the open bond market.
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When you buy from the TreasuryDirect website, you enter a non-competitive bid. This means that if you purchase a $1,000 TIPS, the purchase amount may not be $1,000.
Depending on the current yields versus the bond interest rate, you could pay less or more than the par amount.
You could pay $995 or $1,005, etc. I like to add more money to my account than the par amount I request, just in case prices are high.
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So, for $1,000, I would have at least $1,050 on standby for the purchase. You will adjust to this process quickly; however, I embarrassed myself on my first couple of bond purchases.
Are TIPS right for you? Think of TIPS as certificates of deposit that continue to adjust your principal amount to meet inflation.
Unfortunately, there is a negative to adjusting the principal amount—taxes. You must pay taxes on the adjusted principal yearly, although you didn’t receive this money as income.
I will get into TIPS versus other securities in the following few articles, so today, let’s evaluate them independently.
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We all need to beat inflation; TIPS will help you there. The process to buy TIPS is pretty straightforward as well.
I like to purchase long-dated Treasuries over certificates of deposit because I don’t want to keep re-buying CDs every 1-2 years.
I can simply purchase a 30-year TIPS and let it pay me interest semiannually. I don’t like that I can’t see the compounded principal amount, although I can calculate it.
I have to babysit my TIPS purchases because they happen monthly. I can purchase Series “I” Bonds anytime throughout the month.
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However, TIPS have no annual purchase limit versus $10,000 for Series “I” Bonds. If you are a prominent investor, TIPS will be your best bet.
Conclusion. I still have lots of research to conduct on TIPS. They work best if you buy and hold them—as with most stocks and bonds.
If you want to beat inflation safely, TIPS are an excellent option. I personally go for high-yielding income securities like Closed-End Funds and Preferred Shares.
I can get upwards of 10% yields on these securities, which helps me easily beat inflation. However, I accept risk along with these securities.
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Investors consider TIPS and Treasuries risk-free assets. Therefore, you can safely put your money in TIPS; however, if you need to sell them, that’s a different story.
If you have $10,000 to invest, you will need to divide this money into cash you may need (high-yield savings account), safe investments (TIPS), growth (dividend growth stocks), and high-yield (Closed-End Funds).
TIPS are not the end-all-be-all to beating inflation. They are part of your larger portfolio allocation strategy.
I look forward to buying more TIPS and following their interest payment increases. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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