What are Treasury inflation-protected securities? How do they work?

TIPS become more valuable when inflation is on the rise.

What are Treasury Inflation Protected Securities (TIPS?)?

In the bond world, some of the safest investments are Treasury securities. They are issued by the United States government and carry a AAA rating, the highest level of creditworthiness. Since they reflect the “full faith and credit” of the federal government, they are virtually guaranteed never to default.

A class of treasury bills attempts to protect investments against rising inflation, known as Treasury Inflation-Protected Securities, or TIPS. Their principal increases when inflation increases; conversely, when there is deflation, they lose value.

How do TIPS work?

TIPS have a lifespan of 5 years, 10 years or 30 years. They are linked to the Consumer Price Index (CPI), which means that their principal is adjusted to changes in the CPI, which is the main indicator of inflation. TIPS are different from I bonds, another Treasury security, in that their principal is adjusted for inflation; with I bonds, the composite return, or interest rate, varies with changes in the CPI.

This means that an investor might not receive the face value, or full value, of their TIPS if they decide to sell it before maturity. However, if an investor holds their TIPS until maturity, they receive either the adjusted capital or the original capital—the one who is the greatest. This is one of the ways the government is trying to incentivize investors to commit to the long term by owning bonds.

Do TIPS pay interest?

TIPS offer interest payments on a semi-annual basis. This is called the coupon and it is a fixed rate of return, which means it does not change during the life of the bond.

Additionally, TIPS can be sold prior to maturity and they are traded on secondary markets, which means there is potential for price appreciation since older bonds offer higher coupons than newer bonds. .

How are TIPS calculated?

Each month, the Bureau of Labor Statistics releases a report on the changing cost of daily living. This ratio is known as the consumer price index. The release date schedule is as follows:

CPI Release Dates

Reference month Release date Release time

Apr-22

11-May-22

8:30 am

May-22

June 10, 22

8:30 am

Jun-22

13-Jul-22

8:30 am

Jul-22

10 Aug 22

8:30 am

August 22

13 Sep 22

8:30 am

Sep 22

Oct 13, 22

8:30 am

October 22

10-Nov-22

8:30 am

November 22

13-Dec-22

8:30 am

TreasuryDirect, the US Treasury website, which offers Treasury securities for purchase, also provides links to CPI data and publishes the most recent rates of return for TIPS on this webpage.

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TheStreet Dictionary Terms

Investors can also calculate coupon rates themselves. They simply need to multiply the adjusted principal by half the interest rate.

Are TIPS liquid?

Interestingly, although treasury bills are valued for their liquidity, which means they can be easily converted into cash, treasury inflation-protected securities are not considered as liquid as other treasury securities. , in part because their secondary market simply doesn’t have the volume that other bond markets do.

How are TIPS similar to treasury bills? How are they different?

TIPS are similar to Treasuries in that they are both less volatile than stocks. Owning debt securities can add weight to a portfolio and is considered part of a balanced investment strategy as it provides effective protection against market volatility.

TIPS are different from other classes of bonds because their principal is linked to inflation, so they outperform other types of bonds when inflation is high. But, in the rare cases of deflation, as was the case during the financial crisis of 2007-2008, they lose more value than other types of bonds.

How can I invest in TIPS? Do I need a broker?

You can buy TIPS through the TreasuryDirect website, or through a bank or broker. If the TIPS are held in a TreasuryDirect account, to sell them you will need to transfer them to a bank, broker or dealer who can then sell them on your behalf. This is called the secondary market.

How are TIPS taxed?

The principal and interest of TIPS are subject to federal taxes, although they are exempt from state and local taxes. You need two forms to report your TIPS tax; Form 1099-INT, which shows interest income, and Form 1099-OID, which shows principal. These tax increases are not only due at maturity; investors are required to pay taxes on them each year.

How can you trade TIPS? What are some examples?

In addition to investing in TIPS for the long term, which means holding them until they mature, investors can sell TIPS before their maturity date in the secondary market. TIPS are also available through mutual funds, bond funds, and exchange-traded funds or ETFs.

The largest TIPS ETF is the iShares Barclays TIPS Bond Fund (TIP). Another TIPS ETF, managed by Vanguard, is the Vanguard Short-Term Inflation-Protected Securities ETF (TIPS).

However, investors choosing to hold TIPS held in bond ETFs should be careful about their holding periods. For example, an ETF does not have a maturity date; however, TIPS do, and often there can be a substantial difference in profit between an investor holding TIPS to maturity or not.

Like all bonds, TIPS have an inverse relationship with interest rates, meaning that when interest rates rise, bond prices fall (and vice versa). Thus, investors should also pay attention to interest rate risk when selecting the ETF or bond fund that is best for them.

Are TIPS a good investment?

Given that inflation isn’t expected to go away anytime soon, Dan Weil of TheStreet highlights a TIPS ETF as one of the best “inflation-fighting funds” in the market.

Maria D. Ervin