Often overlooked by retail investors, TIPS, or Treasury Inflation-Protected Securities, are U.S. government-backed, fixed-income securities that offer inflation protection – and often more. After jumping 2% on all maturity lengths last month, TIPS yields are offering the best yields in more than 10 years.
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Treasury Inflation-Protected Securities Explained
TIPS are unique because their payout will change depending on inflation – specifically the consumer price index (CPI) – unlike traditional Treasury bonds.
The bonds are made up of two parts: the purchase price, or principal, and the yield. The yield is set when you purchase the bond but unlike other bonds the principal is adjusted for inflation every six months. When the bond matures if the adjusted principal is higher than the original price, investors get that gain. If the adjusted principal falls to less than the original price, the bondholder still gets their original purchase price.
TIPs pay a fixed rate of interest every six months but those payments aren’t predictable because they will vary during the life of the bond to match the principal as it adjusts to match the rate of inflation at the time. According to Treasury.gov, “The rate is fixed at auction and is never less than 0.125%.”
Interest from TIPS bonds is exempt from state and local taxes, but interest payments are subject to federal tax.
How TIPS Yields Have Jumped
During the week of Aug. 14 the guaranteed yield climbed to 2%, giving investors a guaranteed yield of 2% more than inflation for a duration of up to 30 years. The yield on a 10-year TIPS last month climbed more than 2% – a level not seen for that security since 2009.
As Brett Arends wrote at MarketWatch.com, “$1 invested in TIPS today is guaranteed to be worth $1.80 in real, purchasing power terms in 2053, regardless of what happens, come hell or high water. No inflation, deflation, depression, bear market, or panic will matter.”
