Treasury inflation-protected securities, or TIPS, are a kind of government bond offered by the U.S. Treasury. These securities are designed to keep pace with inflation, helping investors maintain their purchasing power over time.
Understanding about Treasury Inflation-Protected Securities
The value of TIPS increases when inflation goes up. Inflation refers to how quickly prices are rising across the U.S. economy, which is tracked by the Consumer Price Index (CPI). It becomes a concern when real wages don’t grow at a similar pace to counteract the negative impacts of rising prices.
TIPS are a favored choice for safeguarding investments against inflation and even benefiting from it, as they provide interest payments every six months based on a fixed rate set during the bond auction. However, the actual interest payments can change since the rate is applied to the adjusted principal value of the bond. If the principal rises over time due to inflation, the interest payments will also increase because they’re calculated on this higher amount. On the flip side, if deflation happens, interest payments will decrease.
TIPS come with maturities of five, 10, and 30 years and are seen as a low-risk investment since they are backed by the U.S. government. When they mature, TIPS will pay back either the adjusted principal or the original principal, whichever is higher.
Investors can buy TIPS directly from the government via the TreasuryDirect system, starting at $100 and in increments of $100, with the previously mentioned maturities available.
Some investors opt to acquire TIPS through mutual funds or exchange-traded funds (ETFs). However, buying TIPS directly can help investors avoid the management fees that come with mutual funds.
Conclusion
TIPS are one of the various debt securities provided by the U.S. Treasury Department. You can think of them as a unique version of Treasuries since their principal value adjusts with inflation, offering a safeguard for investors when living costs increase. However, they often get a bad rap.
It’s crucial to understand that while TIPS offer inflation protection, this comes with a trade-off, as they typically have lower interest rates compared to other government bonds. Additionally, when they mature, bondholders receive either the inflation-adjusted principal or the original principal, depending on which is higher. This means there’s a safety net in case of significant deflation.
Another frequent misunderstanding is that TIPS will always perform well during inflationary periods and serve as an effective short-term hedge when living expenses surge. As we learned in 2022, TIPS are still bonds, and the bond market tends to struggle when interest rates rise.