TIPS for Investors
By Robert Brokamp (TMF Bro)
June 10, 2003
There are several nemeses to vanquish in the battle to grow your money: taxes, inflation, and the potential loss of principal, to name a few. To aid you in your struggle, permit us to suggest some TIPS: Treasury Inflation-Protected Securities, also known as Treasury Inflation-Indexed Investments.
Brought to you by the U.S. government (the same people who brought you the confusingly quarter-shaped Susan B. Anthony dollar, which was improved upon with the quarter-shaped Sacagawea dollar), TIPS are Treasury notes that are guaranteed to keep up with inflation. Unlike I Bonds, which feature an inflation-adjusted interest rate, TIPS subdue inflation by pumping up the principal.
How? The face amount of the security is adjusted to account for the rising cost of living, as represented by the Consumer Price Index. For example, if the CPI rose 3% and you had $10,000 invested in TIPS, then $300 would be added to your principal. But that's not all. Your next interest payment will be based on the higher principal amount. Therefore, your interest payments will rise, too.
When the note matures, you'll get the inflation-adjusted principal. (In the unlikely event of deflation, you won't get back less than your original investment.) Here are some other good, and not-so-good, aspects of TIPS:
Pros
- TIPS are U.S. government securities, which are considered the safest investments in the world.
- Like all other Treasuries, TIPS are exempt from state and local taxes.
- TIPS can be purchased commission-free at treasurydirect.gov.
Cons
- The amount added to the principal is taxable in the year it is added, though you won't realize that gain until the TIPS mature. That's why some experts recommend that TIPS are best kept in tax-advantaged accounts, such as IRAs.
- TIPS are only offered in 10-year maturities, though you can purchase TIPS with other maturities on the open market (i.e., from a broker). Another convenient way to invest in TIPS is through the low-cost, no-load Vanguard Inflation-Protected Securities Fund (though bond funds have their own pros and cons).
- You hope you never get rich from TIPS. The only scenario in which TIPS would provide an outstanding return is if inflation goes through the roof. Though that might make for a fat interest check every six months, it probably means the rest of the economy is in the dumps.
Want to learn more? See your tax dollars at work by visiting the Treasury Department's website. If you're looking for other places for your "safe" money, check out our Short-Term Savings Center (featuring special Fools-only CD and money market rates).
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