How TIPS helps protect investments from inflation
TIPS does not stand for helpful suggestions or gratuities for a server. Instead, TIPS is short for “Treasury Inflation-Protected Securities,” which are helpful to those trying to protect their investments against inflation. The investment is based on the Consumer Price Index, and here’s how it works:
How TIPS protect investors from inflation
TIPS are marketable securities with a twist. The principal varies depending on fluctuations in the Consumer Price Index. When the CPI goes up, which is also known as inflation, the TIPS principal amount rises, too. In times of deflation, when the CPI goes down, the principal is adjusted on the same scale.
TIPS do pay fixed-rate interest every six months. But since the principal itself fluctuates, the interest paid is not entirely predictable the way it would be with some other types of bonds. Sometimes that is great news. If you invested in a 10-year Treasury bond that paid 4 percent regardless of inflation and then the CPI took off, the inflation would cut into your overall gain since the interest wouldn’t keep pace with inflation. With tips, any inflation would be offset by a higher principal amount.
The downside of TIPS
TIPS work as a hedge against inflation without the risks associated with commodities or precious metals. They’re also backed by the U.S. Treasury and are guaranteed to pay interest. But there are drawbacks. The built-in flexibility usually means a lower interest rate than traditional bonds at the outset, for example. And if the CPI has zero growth, you’ll be stuck with that lower rate even though you didn’t get an increase in your principal.
If TIPS seem like a viable portfolio option, you can buy them through your bank or broker or online at the U.S. Treasury website. The minimum purchase price is $100 and the term is five, 10 or 30 years. You can also turn to the secondary market to sell TIPS before they mature.