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Treasury Inflation-Protected Securities (TIPS) are a form of bond issued by the U.S. government whose principal value and interest payments are adjusted in accordance with changes in the Consumer Price Index (CPI), which tracks inflation.
TIPS are offered for auction with maturities ranging from five to thirty years. While the principal value is adjusted in accordance with the CPI every six months, the interest rate is fixed at the time of issuance. The principal value of TIPS increases in tandem with inflation, and vice versa. The interest payments also rise or fall with inflation because they are based on the updated principle value.
TIPS repay either the initial principal amount or the increased principal amount at maturity, whichever is larger. This means that even in a deflationary environment, investors will always get back more money than they put in. Investors will, however, make a profit over their initial investment if there is inflation.
What Are the Benefits of TIPS?
Investors who wish to keep their purchasing power and prevent losing money to inflation can benefit from TIPS in a number of ways. Some of these benefits are:- Guaranteed real return: TIPS offers a guaranteed real return over inflation since they alter their principle value and interest payments in accordance with inflation. This implies that over time, investors can keep up with or raise their standard of living.
- Low risk: TIPS are essentially risk-free because they are supported by the U.S. government's full faith and credit. They are less volatile than other types of bonds since interest rate fluctuations do not cause them to alter considerably.
- Tax benefits: State and municipal taxes on income are not applied to TIPS. A tax-deferred account, such as an IRA or 401(k), is also available to them.
What Are the Drawbacks of TIPS?
Investors should be informed of the disadvantages of TIPS before making an investment. Some of these drawbacks are:- Low nominal return: TIPS often have lower nominal returns than conventional bonds with identical maturities because they offer insurance against inflation. This means that if inflation is low or negative, investors may experience a decrease in nominal returns.
- Tax implications: TIPS are not subject to federal income taxes on the principle value changes, but they are liable to federal income taxes on the interest payments, even though TIPS are free from state and local income taxes. As a result, investors who have not yet received their income in cash may need to pay taxes on it.
- Liquidity risk: Due to their limited market size and lack of buyers and sellers, TIPS are less liquid than traditional bonds. As a result, investors who require cash may find it challenging to sell them promptly or for a reasonable price.
How Can You Invest in TIPS?
According to your interests and aims, there are various ways to invest in TIPS. You can purchase them straight from the U.S. Treasury by visiting TreasuryDirect.gov, or you can do it through brokers or dealers who take part in Treasury auctions. They are also available for purchase on the secondary market from brokers or dealers who deal with them after issuance.Another choice is to add TIPS to one's portfolio or invest in mutual funds or exchange-traded funds (ETFs) that focus on them. These funds provide lower transaction costs, professional management, and diversification among several TIPS issuers and maturities.
Nevertheless, investing in funds entails incurring costs and fees that lower your returns as well as the possibility of tracking errors that could result in a performance difference between your fund and its benchmark index.
