What are TIPS? (Article)
What are TIPS?
Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds that adjust with inflation and deflation as measured by the CPI or Consumer Price Index. TIPS are looked to as a low risk option to protect an investor’s purchasing power of their money. Let’s suppose that an investor purchased a TIPS bond for $1,000 with a 2% interest rate. If inflation for the year was 3%, the principal value of the bond would be adjusted upward to $1,030. The 2% rate of interest would then be calculated based on this new, larger amount resulting in more interest being paid. A decline in inflation would have the opposite effect. Importantly, a TIPS bond will never fall below the original principal amount when it matures; you are paid the adjusted principal amount or the original.
TIPS can be purchased individually from the government in $100 increments and are available with 5-, 10-, and 30-year maturities. Other options to gain access to TIPS include buying them in a basket via an ETF (Exchange Traded Fund) or in an open-end mutual fund that has a specific mandate to invest in TIPS. For tax efficiency, consider owning them in qualified retirement plans.
TIPS are generally considered to be a lower-risk investment, but investors should not forget that like other kinds of bonds they are subject to interest rate risk. Prior to maturity, the value of a TIPS bond could decline in value as interest rates rise or increase should rates fall.
Ultimately, TIPS are a good diversifier in a long-term portfolio and serve an important component in maintaining the purchasing power of your hard-earned savings.
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