For several years now, the U.S. Department of the Treasury has offered bonds that can help protect against inflation. They’re called Treasury Inflation Protected Securities, or TIPS. The bonds are issued with maturities of five, 10 and 30 years, and can help shelter you from inflation risk because their principal is adjusted semiannually for inflation based on changes in the Consumer Price Index-Urban Consumers (CPI-U).
The CPI-U is a widely used measure of inflation. Interest payments are calculated on the inflation-adjusted principal. So, if inflation occurs throughout the life of the bond, interest payments increase. At maturity, if the adjusted principal is greater than the face or par value, you receive the greater value. If you’re new to TIPS, here are answers to five common questions:
1. Who issues TIPS?
TIPS are issued by the federal government and backed by its “full faith and credit” guarantee. TIPS may be purchased for an amount as low as $100. Interest earned is paid twice a year and subject to federal income tax, but not state and local income taxes.
2. Where can I buy TIPS?
TIPS can be purchased electronically from the U.S. Treasury through TreasuryDirect. TIPS purchased directly from the Treasury are sold in single-price auctions where everyone gets the same price, which is equal to the highest accepted yield at that auction. Use Treasury’s Tentative Auction Schedule to find advance auction dates and its Offering Announcement page to find officially scheduled auctions. You can also buy TIPS through a financial institution or broker. The price of TIPS purchased from a financial institution or broker may vary, so it’s a good idea to shop around.
3. What happens if deflation (a negative inflation rate) occurs — would my TIP investment be worth less than what I paid for it?
No, unless you paid more than the face value of the bond or sell it before it matures. Upon maturity, the Treasury Department agrees to pay the initial face value of the bond or the inflation-adjusted face value, whichever is greater.
4. Is there a trade-off for my inflation protection?
Yes. The trade-off is that the base interest rate on TIPS is usually lower than that of other Treasuries with similar maturities. When inflation is low, other Treasury securities might offer better returns.
5. Can I sell TIPS before they mature?
Yes, TIPS are liquid. You can buy and sell TIPS in the secondary market before maturity. But be aware that the price you receive is subject to market valuation. This may result in either a capital gain or loss, depending on the prevailing market price at the time of the sale.
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