TIPs Bonds – Perfect Investment to Protect Cash From Inflation

By in Bond, Inflation, Investing | 3 comments

 TIPs Inflation Bonds – Protect Your Cash From Inflation

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”  Ronald Reagan 

Since inflation has been tame in recent years, it’s easy to forget about it’s violent impact. Yet, TIPs bonds can protect your cash from rising interest rates. 

One of President Reagan’s (1981-1989) political challenges was combating the rampant inflation of the time. He entered office after record levels of inflation!

Here are the inflation rates from 1975 to 1986: 

YEAR AVERAGE INFLATION
1986   1.91%
 1985   3.55%
  1984   4.30%
 1983   3.22%
 1982   6.16%
 1981   10.35%
  1980   13.58%
 1979   11.22%
 1978   7.62%
 1977   6.50%
 1976   5.75%
 1975   9.20%

Inflation is devastating financially. If you bought a video game in 1975 for $47.38, that same game would cost $100.00 in 1985. That’s over a 100% price increase in 10 years. Watch out, inflation is inching up now. 

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TIPs Bonds – How to Protect your Money from the Ravages of Inflation

TIPs-the #inflation solution.

Recently, we discussed I Bonds as a way to ensure that your investment keeps up with  inflation. Even with 3% inflation per year (the historical average), your $10.00 meal out will cost $13.44 in 10 years. Now, bump inflation up to 5% and watch that $10.00 meal go up to $16.29. Next, apply those inflation increases to everything you buy. 

Treasury Inflation Protected Securities or TIPs bonds have the same goal as Series I Savings Bonds, to protect your cash from inflation risk.

What is an Inflation Bond?

Like I Bonds, TIPs are bond-like investments issued by the US government. They have a fixed interest rate but they keep up with inflation because when inflation rises, the principal amount of the security (bond) also increases. On the flip side, when inflation drops, so does the principal amount of the bond. You can by TIPs bonds and learn more at the treasurydirect.gov website.

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What are Treasury Inflation Protected Securities (TIPS)?

TIPs Inflation Bonds 101

Buy a government bond and you are making a loan to the U.S. Government.

In exchange for the loan, the government pays you interest.

 What are TIPs Inflation Bonds & How does the TIPs investment work?

 With TIPs bonds, the interest rate is set at the purchase date and stays the same.

The face or principal value of the TIPs bond goes up and down with the inflation rate.

When the principal increases (decreases) you will get a greater (smaller) interest payment on the new principal amount. 

When the TIPS security matures, you get the higher or original principal amount back; At maturity, you never get a smaller principal.

Facts About TIPs bonds:

You can buy them on-line at Treasury Direct.gov. They can be purchased in increments of $100.00.

TIPs have maturities of 5, 10 and 30 years.

You can hold TIPs until maturity or you can sell the securities in the open market through an investment brokerage company like Charles Schwab, E*TRADE, Fidelity, Vanguard, or TD Ameritrade.

TIPs bonds have tax benefits. The inflation bonds are only subject to federal tax, not state or local. You pay the tax in the year it is earned.

What is a TIPs Fund?

There are several mutual funds which hold many TIPs in varying maturities. You can buy a TIPs ETF or mutual fund through your discount brokerage firm. Currently, the rock bottom interest rates are calling into question the viability of owning TIPS. But, as interest rates and inflation begins to rise, TIPs inflation bonds are sure to gain in popularity.

How do I Bonds & TIPS Compare?

  TIPS I Bonds
Type of Investment Marketable bonds-can be bought & sold thought investment companies. Can buy TIPs funds. Non-marketable. Bought through treasurydirect site, bank or some employers.
Face Amount (PAR) Minimum $100 for individual TIPs bond. Fund price set by investment companies and supply and demand. $25 or more. Can buy up to $10,000/year, plus an additonal $5,000 with your tax return.
Interest Payments Set semiannually-paid on adjusted principal Interest is accrued over life of bond & paid upon redemption
Lifespan TIPs funds can be held indefinitely. Individual TIPs can be held to maturity (5, 10, or 30 years) or sold prior in the secondary market. Redeemable after 12 months (with 3 months interest penalty). No penalty after 5 years. Earn interest up to 30 years.
How they keep pace with inflation

The interest rate is set at the purchase date and stays the same.

The face or principal value of the TIPs bond goes up and down with the inflation rate.

I Bonds receive a combined interest payment. The fixed interest rate is set when you buy the bond. Every 6 months the variable interest rate changes, based upon the inflation rate. 

How a TIPs Bond Protects You From Inflation Risk

Inflation risk manifests insidiously by causing the same dollar to purchase less and less product(s).  Another way to look at inflation is; the identical goods cost more and more. A savings account or CD (Certificate of deposit) is subject to inflation risk as the interest rate stays the same even though inflation may be rising. If you buy a CD playing 2% interest and inflation rises to 3%, then your money is losing 1% due to inflation.

 Series I & TIPs government bonds protect your money from inflation risk.

Read about Governement I Bonds in Part 1 – The Best Investment to Keep Pace With Inflation, Guaranteed

Updated; March 28, 2018

 

    3 Comments

  1. Thank you very much!Your article is very useful!

    infant

    May 5, 2010

  2. You can also invest in TIPs via ETFs. There are a few low-cost funds listed on the New York Stock Exchange. These funds are necessarily a better way to invest than buying TIPs dircetly. It is just another option available.

    ctreit

    May 5, 2010

  3. @cool & @ infant, Thanks for reading. I appreciate your comments and visits! @ctreit- Yes, ETF’s are great for occasional purchases, thanks for mentioning. Although, they aren’t great for frequent purchases since you pay commissions on each ETF transaction. Best regards, Barb

    Barb

    May 7, 2010

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