Just like there are mutual funds and ETFs that invest in stocks, there are mutual funds that invest in TIPS. I show a list of them in More Inflation Protection with TIPS After Maxing Out I Bonds.
Mutual Fund/ETF Advantages
Buying TIPS through a mutual fund (or ETF) is a good idea, because it gives you a lot of convenience for a small price.
Buy at any time without a transaction fee
Although there is no charge to buy individual TIPS bonds at auctions through many brokers (Vanguard, Fidelity, Schwab), the auctions only come up once a month. If you want to buy individual TIPS bonds when there’s no auction, you must buy them on the secondary market and pay a bid/ask spread. Or you will just have to wait until the next auction, but the prices will have changed by then.
A mutual fund holds many bonds with different maturities. You get all of them with one purchase. If you are buying individual TIPS bonds, they don’t come on auction at the same time. You must wait for the auctions or pay a bid/ask spread to establish your positions.
Sell at any time without a transaction fee
If you have individual TIPS bonds, there is no fee if you wait until they mature. If you want to sell before they mature, you will have to sell them on the secondary market and pay a bid/ask spread.
Buy or sell any random amount
The individual TIPS bonds are in $1,000 increments in a brokerage account. A mutual fund or ETF doesn’t have that limitation. Rebalancing is much easier when you use a mutual fund or ETF.
Reinvest interest payments immediately
If you have individual TIPS bonds, you must hold the interest payments elsewhere. Reinvesting in another TIPS bond is also subject to the auction cycles and $1,000 increments in a brokerage account.
Easy tax handling
Individual TIPS bonds in a taxable account require special handling, which I won’t go into detail here. Holding TIPS in a mutual fund or ETF shields that issue away from you. You receive regular dividends from the fund and you get a 1099 form after the end of the year just like any other mutual fund or ETF.
Individual TIPS Advantages
All of these conveniences in a mutual fund or ETF come at a cost of under 0.10% a year. That’s $10 a year for each $10,000 invested. That’s very reasonable to me. Why bother buying individual bonds then?
If you buy at auctions and hold to maturity, there’s no extra expense. If you buy a large amount, you can save money by building your own fund with individual bonds.
Vanguard, Fidelity, and Schwab charge no fee if you buy at auctions and hold to maturity. Even if you buy on the secondary market, as long as you buy long-term bonds in large chunks and hold the bonds to maturity, a one-time bid/ask spread can be less expensive than having to pay an ongoing expense year after year.
Be your own fund manager
You get to decide what maturity you buy. When you buy fund shares, you buy a basket of underlying holdings in the fund. The fund’s experienced managers decide what to buy and when to buy. With individual bonds, now you become the amateur manager of your own fund. Want short maturities? Buy 5-year TIPS. Want long ones? Buy 30-year TIPS.
If you’d like to buy at auctions and hold to maturity, I have a step-by-step guide for doing so.
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