[First published in 2022. Updated on August 25, 2023.]
After you bought all the I Bonds you could buy in your personal account, trust, business, as gifts, from your tax refund, and for your kids, now what? Should you keep buying them every year?
I Bonds are great, but they’re better for the short term than the long term when the fixed rate is low. Although the Treasury Department raised the fixed rate on I Bonds to 0.9% for new I Bonds bought between May and October 2023, it’s still much lower than the current real yield on TIPS, which are another type of government bond with inflation protection.
I have a lot to say on this topic because I wrote a book about TIPS back in 2010. Amazingly little has changed in all these years. Specific interest rates changed and some new mutual funds and ETFs came out, but the principles are still the same. I’ll give you the gist of TIPS in this post.
What Are TIPS?
TIPS are Treasury Inflation-Protected Securities. They’re a type of bond issued by the U.S. government. Both the principal and the interest are linked to inflation. If inflation goes higher, you get paid more interest and the principal repayment also goes higher.
No Purchase Limit
The biggest advantage of TIPS over I Bonds is that there’s no annual purchase limit in TIPS. You can buy as much TIPS as you want, in all types of accounts — including IRAs and HSAs, at a broker you already use, both as individual bonds and in a mutual fund or an ETF. You don’t have to use TreasuryDirect to buy TIPS.
Higher Yield
TIPS yields were negative during some periods in the past, which meant investors were guaranteed to lose to inflation when they bought TIPS at that time. As I updated this on August 25, 2023, the yield on 5-year TIPS was +2.15%. This means if you buy a 5-year TIPS and hold it for five years, you’ll beat inflation by 2.15% per year. This is much better than the fixed rate on I Bonds. The yield on TIPS hasn’t been this high for a long time.
The market will continue to change. The yields on TIPS may go up some more, or they may come back down. You can see the latest yields on TIPS of different maturities on the Interest Rate Statistics page at TreasuryDirect (click on the second heading for Daily Treasury Par Real Yield Curve Rates) or on this page from Wall Street Journal.
Interest Rate Risk
A disadvantage of TIPS over I Bonds is the interest rate risk.
I Bonds are guaranteed never to lose money regardless of when you cash out. You forfeit the last three months of interest when you cash out within five years but you’re guaranteed to have your principal back plus the interest you get to keep. They behave like a bank CD.
It’s a different story with TIPS. You’re guaranteed to have your principal back only when you hold TIPS to maturity. If you must sell TIPS early, you get the market value, which can be higher or lower than your original investment plus interest and inflation adjustments.
Bond prices go down when market interest rates go up. You can lose money in TIPS over the short term even when inflation is high. For instance, Vanguard Inflation-Protected Securities Fund (VAIPX) invests 100% in TIPS. Its year-to-date return through August 2024, 2023 was only 0.53%. The short-term return was low because market interest rates went up in those months.
The 0.53% short-term return on the TIPS fund was actually not much better than the return on a comparable non-TIPS bond fund. For instance, the year-to-date return on Vanguard Intermediate-Term Treasury Index Fund (VSIGX) was 0.28% in the same period.
Both a TIPS fund and a regular bond fund have interest rate risk. A TIPS fund can perform better or worse than a regular bond fund over any period.
Breakeven Inflation Rate
The tradeoff between TIPS and non-TIPS bonds comes down to how much inflation there will be in the future. No one knows. The market participants come out with an estimate. That’s the breakeven inflation rate, which is the difference between the yield on TIPS and the yield on nominal Treasury bonds of the same maturity. You’re better off with TIPS if inflation in the future comes out above this breakeven inflation rate. You’re better off with regular Treasuries if inflation in the future comes out below this breakeven inflation rate.
| Future Inflation | Better Off With |
|---|---|
| > Breakeven Inflation Rate | TIPS |
| < Breakeven Inflation Rate | Regular Bonds |
David Enna at TIPS Watch tracked the breakeven inflation rate at the time when TIPS bonds were first issued versus the actual inflation experienced during their lifetime. The data showed the market is always wrong about what future inflation will be. Sometimes the market estimated the future inflation too high. Sometimes the market estimated too low.
You see the current 5-year breakeven inflation rate and 10-year breakeven inflation rate from the Federal Reserve Bank of St. Louis. It’s between 2.0% and 2.5% at this moment. You don’t know which way they’re wrong or by how much.
When to Invest in TIPS
Most of the questions on TIPS are really on whether it’s a good time to invest in TIPS right now.
Is it the best time to invest in TIPS right now?
It’s not. The best time to invest in TIPS was October 2008 when you could’ve locked in a positive 3% yield above inflation for 20 years but we don’t have a time machine.
Should I wait until TIPS yields go higher in the coming months?
No one knows whether the yields on TIPS will go higher or lower. Money waiting in the wings loses to inflation.
Is it better to switch from other bonds to TIPS now when inflation is high?
No one knows. High inflation isn’t a secret. When everyone expects high inflation, the breakeven inflation rate is also higher. The breakeven inflation rate compensates investors in other bonds for their lack of inflation protection.
Market participants collectively come to the conclusion that the current yields on TIPS and other bonds make them no better off or worse off one way or the other. You’re better off in TIPS when the market underestimates future inflation but no one knows whether the market is underestimating or overestimating right now.
Handicapping whether inflation in the coming years will be above or below the current breakeven inflation rate isn’t a good way to invest.
Then how do you decide whether to invest in TIPS right now or not?
You decide by whether you want inflation protection or you want to take your chances relative to inflation.
When you invest in TIPS, you know how much you’ll earn or lose over inflation. Invest in TIPS if you’re satisfied by this number no matter what inflation turns out to be in the future. Other fixed-income investments may end up doing better or worse than TIPS but you don’t care. Your goal is to protect your investments from inflation.
On the other hand, if you don’t mind losing to inflation for a chance to beat more, you don’t need to go out of your way to invest in TIPS. No one knows whether TIPS will do better or worse.
Finally, there’s always diversification. You don’t have to go either 100% TIPS or zero TIPS. You can invest in both TIPS and other bonds.
How to Invest in TIPS
If you decide to invest at least some money in TIPS, you can either buy individual TIPS or buy a mutual fund or an ETF that holds TIPS. Buying a mutual fund or an ETF is the easiest, in the same way as you invest in other bonds for the long term. When you’re new to TIPS, start with a mutual fund or an ETF unless you’re planning to liquidate all your holdings on a specific date or over a short period of time. See Two Types of Bond Ladder: When to Replace a Bond Fund or ETF.
The popular total bond market index funds and ETFs don’t include TIPS. Investing in both a TIPS fund and a total bond market index fund will make your bond investments more complete.
As in other bonds, short-term TIPS have a lower interest rate risk than longer-term TIPS but, in general, they also have a lower yield. These funds invest in short-term TIPS (maturities up to 5 years):
| Minimum Investment | Expense Ratio | |
|---|---|---|
| iShares 0-5 Year TIPS Bond ETF (STIP) | None | 0.03% |
| Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) | None | 0.04% |
| Vanguard Short-Term Inflation-Protected Securities Index Fund (VTAPX) | $3,000 | 0.06% |
These funds invest in TIPS of all maturities:
| Minimum Investment | Expense Ratio | |
|---|---|---|
| Fidelity Inflation-Protected Bond Index Fund (FIPDX) | None | 0.05% |
| Schwab Treasury Inflation Protected Securities Index Fund (SWRSX) | None | 0.05% |
| Schwab U.S. TIPS ETF (SCHP) | None | 0.05% |
| Vanguard Inflation-Protected Securities Fund Admiral Shares (VAIPX) | $50,000 | 0.10% |
Buying individual TIPS gets more complicated. Please read my book Explore TIPS if you’re interested in buying individual TIPS.
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Walt says
As an alternative, I bought 2-year Treasury notes yielding 2.5% after maxing out my I-Bond purchase.
RobI says
One thing that’s confusing me is what dividend gets paid out with TIPS. Would the actual $ amount be the rate of inflation less the effective yield so roughly (8.5%-0.5%)?
This still seems a heck of a lot better than regular bonds right now but maybe I’m missing something!
Harry Sit says
The dividends from a fund are more complicated than a simple yield-plus-inflation calculation due to capital gains and losses within the fund but, in general, the dividend distributions go up with inflation. For instance, the Schwab fund SWRSX distributed $0.61 per share in the last 12 months. That comes out to about 5.2% of the current share price.
pdb says
If you’re paying taxes each year on the increase in the principal from the inflation adjustment, have you factored into your personal yield the present value of taxes that must be paid on money not received for xx years, or am I incorrect in thinking this isn’t taken into account?
Harry Sit says
When you invest in TIPS through a mutual fund or ETF, the fund pays out the increase in the principal value each year. Taxes work the same as in any other bond fund.
VictoriaF says
As of May, 08, 2022, comparing Vanguard’s short-term (VTAPX) and regular (VAIPX) TIPS funds:
– in the past 1 year VTAPX (2.95%) > VAIPX (0.59%), and
– in the past 3 years VAIPX (5.27%) > VTAPX (4.16%).
Why did VTAPX outperform VAIPX in the last 1 year?
In my Roth IRA, I want to have a “safe” fund that won’t lose to inflation in the long run. I don’t have any specific dates that I need to match with this fund’s duration. Will I be safer with VTAPX or VAIPX?
Harry Sit says
Both the short-term TIPS fund (VTAPX) and the all-maturity TIPS fund (VAIPX) are indexed to inflation in the same way. In general, the short-term fund has lower risks and lower returns than the all-maturities fund. Neither is guaranteed not to lose to inflation in the long run. When the yields were negative a year ago, both lost to inflation. The short-term fund lost more. The all-maturities fund lost less.
Interest rates rose in the last 12 months, especially since January 2022. This caused the all-maturities fund to do worse than the short-term fund. It will continue this way if interest rates continue to rise in the next 12 months. When interest rates stop going up and stay there (or start going down), the all-maturities fund will do better than the short-term fund.
It isn’t a good way to invest by predicting whether interest rates will continue to go up, when they will stop going up, or when they will start going down. The all-maturities fund has a better chance not to lose to inflation in the long run (lose less or beat more) than the short-term fund but it comes with a higher interest rate risk, as you’ve seen in the last 12 months.
Old mariner says
Hi Harry, do you have any thoughts about the 10-yr TIPS auction on May19th? Good time to buy, not a good time to buy? I read one analyst (David Enna) thinks it’ll go positive. I’m looking for somewhere to park some cash for my older-than-now years. I’m maxxed out on i-bonds.
Harry Sit says
The yield is currently positive at about +0.25%. It’s higher than it was two weeks ago but lower than it was one week ago. As in investing in anything else, you’re always taking a chance that the price will go lower after you buy or that something else would’ve done better. I can’t predict whether the yield will go higher or lower in the near future if you wait or whether you’ll realize in 10 years it did better or worse than a regular 10-year Treasury.
George says
When a TIPS is purchased at a reopening (and accrued interest and accrued inflation is paid), will the purchaser receive at maturity all accumulated inflation (OID) beginning from the reopening issue date, or instead, beginning from the original issue or dated date?
Harry Sit says
The way you expect to be fair. Suppose the bond was issued for $1,000 and by the time you buy it, inflation has made the original $1,000 worth $1,100. So you pay $1,100. If inflation makes that $1,100 worth $2,200 when the bond matures, you get $2,200.
George says
Thank you. Then, unlike accrued interest paid (recovered at the next coupon date), accrued inflation paid is never recovered later. So to be fair, is the accrued inflation ($100) able to be amortized (along with any other premium in other cases) over the remaining term of the reopened TIPS (to offset the $1100 taxable inflation OID and coupon interest paid)?
Harry Sit says
Accrued inflation works similarly to accrued interest, just on a longer time frame. It is recovered. Suppose someone bought at the original issue for $1,000 and you bought at the reopening for $1,100. Both of you will receive $2,200 when the bond matures. You can see it as receiving the full $1,200 that recovers the $100 accrued inflation you paid, similar to how the next interest payment recovers the accrued interest.
George says
Thank you for the 5/26 response. I know we must pay tax on the inflation increase in premium in each tax year. In your example above, suppose the TIPS goes on to have $400 in inflation-increased principal between reopening, when I paid $1100 to buy it, and year end, i.e., it gained $500 overall since the original issue price of $1000 in that same tax year. Since I will be repaid at maturity the accrued inflation of $100 that I paid at purchase, do I now need to pay tax on the full $500, or only on my gain of $400?
Harry Sit says
You will pay tax only on $400.
DB says
If you purchase TIPS in a Traditional IRA and then want to do a Roth conversion, does it require selling the TIPS in Traditional IRA and repurchasing them in Roth IRA or do the shares get moved in-kind from Traditional IRA to Roth IRA and you pay taxes on the conversion as usual?
Harry Sit says
It doesn’t require selling and repurchasing. The assets move in-kind and you pay taxes on the dollar value. This is the same for all assets, not just TIPS.
DB says
If both ROTH and Rollover IRA are held in the same brokerage, what is the process for Roth IRA conversion of individual TIPS and Treasury bonds? Do you need to go through Treasury Direct or do you just do the conversion as you would with other mutual funds or ETFs?
Harry Sit says
A Roth conversion moves assets in-kind from a traditional IRA to a Roth IRA. You don’t have to sell and it doesn’t go through TreasuryDirect.
DB says
Thanks Harry. I wanted to double check because when I tried to transfer a TIPS bond from one brokerage to another for consolidating assets, I was informed that it can only be done by filling out a Treasury Direct form. Is that the normal procedure for transferring Treasury bonds between brokerages?
Harry Sit says
I’ve never heard of it. Maybe they misunderstood you. You fill out a TreasuryDirect form only when you’re moving bonds from TreasuryDirect to a brokerage account, not between two brokerage accounts. You move assets between brokerage accounts by filling out a transfer of asset form at the receiving firm. The receiving firm sends the request through ACATS to the delivering firm.
DB says
This was with online asset transfer request submitted to Fidelity and I provided the TIPS CUSIP. Someone then called back and informed me that I need to go through Treasury Direct.
Have you tried it with Fidelity. What is the process you normally follow?
Harry Sit says
An online asset transfer request is the correct process when you’re trying to get the TIPS bond transferred into your Fidelity account. You choose either a full account transfer or a partial transfer of specific assets. Where is this TIPS bond now? It sounds like they thought your TIPS is currently held at TreasuryDirect.
DB says
The treasury bond is at another brokerage. The online asset transfer request clearly specified the brokerage name, but the Fidelity rep who called me didn’t seem very familiar with the process to transfer them. He spoke to someone else at Fidelity and called back to say I had to go fill out a form at Treasury Direct. I didn’t proceed with the transfer as the process didn’t seem straightforward.
George says
If I buy a $1000 face value 5-yr. TIPS at auction in April at negative yield-to-maturity (YTM) and premium of $100, I’ll get the minimum .0625% interest in October, and inflation adjustment on $1000 from April to Dec. I owe tax on the interest and the inflation, but may offset these by allocating the $100 premium over my years of the TIPS ownership: for April to Oct., I can allocate $0.625-$1100*YTM (positive, as YTM is neg.). Q: Can I alloc. prem. for Oct. to Dec., or must wait a yr. & use full period ending April?
Harry Sit says
The accrual period used in calculating premium amortization must have a scheduled payment of principal or interest on the first or the final day. Therefore if you allocate April to October, you can’t allocate October to December (no scheduled payment during this period). See IRS Publication 550. In practice, just go by the bond premium number reported on your 1099. You don’t have to calculate it yourself.
DB says
I had a question about calculating Market Discount. In the Explore Tips book, it isn’t clear if the example provided used adjusted price or unadjusted price as they both are the same in the example used. Which one should be used for calculating market discount?
Is Market Discount reported by the brokerage firm if you buy TIPS in a taxable account at a Brokerage?
DB says
The example used in the book is $10,000 * (1.00000 – 99.811 / 100) = $18.90
I assume 1.0000 is the index ratio on the date of issue? Is 99.811 adjusted or unadjusted price?
Harry Sit says
You use the adjusted price. Brokers are supposed to report the market discount when you sell or when the bond matures.
DB says
Thanks Harry for the clarification on market discount.
Regarding reporting Original Issue Discount for the year of maturity of TIPS matures, I assume one subtracts the inflation index on 1/1/2027 from inflation index for the date of maturity?
Assume that the TIPS matures on 4/15/2027. Is it correct to subtract inflation index on 1/1/2027 from the inflation index on 4/15/2027 rather than 1/1/2028?
Harry Sit says
That’s correct. The OID stops on the maturity date.
George says
Regarding your May 26, 2022 at 1:49 pm response on reopenings, here is a question. Your response said: Suppose the bond was issued for $1,000 and by the time you buy it, inflation has made the original $1,000 worth $1,100. So you pay $1,100. If inflation makes that $1,100 worth $2,200 when the bond matures, you get $2,200.
Q: If the reopening bid price is $1050 instead of $1000, the accrued inflation is applied by idx ratio 1.1, and I paid 1050*1.1=$1155. Is the extra $55 accrued inflation I paid ever recovered?
Harry Sit says
The price is $1,050 when the yield is lower than the stated interest rate on the bond (the “coupon”). That’s a bond premium, not accrued inflation. You get the extra $50 back in small bits and pieces from each interest payment over the remaining life of the bond.
George says
Thank you for the above response; I mistyped $55 in the last line, but meant $5. To clarify the question, initial issue price is at par of $1000 and index ratio is 1.0, then at the (later) reopening, the index ratio for inflation is 1.1, and the auction price is $1050, and the total cost is $1155 after accrued inflation. The accrued inflation is multiplied to get $1155 (NOT added to get $1150). Q: Is the extra $5 of accrued inflation ever recovered? Thanks!
Harry Sit says
It’s easier to think in constant dollars in TIPS. Treat them as a different currency if that’s helpful (think “Euros”). The bond premium is 50 “Euros” worth $55 today. When the 50 “Euros” is paid back in bits and pieces through interest payments, so is your $55. There’s no extra $5. The $50 and the $55 are the same thing, just in different units.
Lizzie says
New to TIPS here. Say I buy $100 of TIPS paying 2% and after 6 months the inflation adjustment is 5%, does this mean that my principal is now $105 & interest earned is $1.05? Am I understanding this correctly – everything is done on a six month basis?
Harry Sit says
Yes, and you don’t have to worry about those details when you buy a TIPS fund, which I recommend for people new to TIPS.
Lizzie says
Thank you Harry
Mary says
I just bought your TIPS book and started following your instructions on how to find out what the purchase price will be. The book is well-written and the links I have used so far all work! I really like the Pricing worksheet. So just to make sure I understand this correctly, in your example in the Pricing worksheet, if I had placed an order for $10,000, then my purchase price would be around $11,111 correct?
I wanted to practice using the worksheet, so I used the current auction announcement for 10-year TIPS. I entered the information from the announcement and used .46% for the yield. The price per bond comes out to 996.78482, which means it will be less than the order amount, correct?
I’m planning to buy 5-year TIPS in the October auction, so I still have time to learn more about it. In your blog here, you say something about if the yield is negative, it may not keep up with inflation. But I thought I heard that TIPS are guaranteed to at least beat inflation (if you hold them to maturity), so I’m confused about that. The yield for 5-year notes is .46 now so maybe that’s not an issue.
Harry Sit says
That’s correct. The best way to practice is to use it on completed auctions in the past. You can then compare the worksheet with the actual results.
When I first wrote this in April, the yield on the 5-year TIPS was negative. It has turned positive since then. If the yield is negative, holding to maturity will still trail inflation. If the yield is positive, holding to maturity will beat inflation.
Mary says
Thanks Harry. I’ll wait to see what the auction results are later this week and do the calculations you talk about in “Read the Auction Result”. Then I’ll see what the final price is and compare it to the price from the worksheet.
For a new issue, can there be a discount or premium, or is that just for a reopening?
Harry Sit says
There will be a slight discount because the coupon rate is rounded down to the next 0.125% increment from the yield (minimum 0.125% when the yield is negative or lower than 0.125%).
Jimbo says
Is there any way to recover the taxes paid in a taxable account on “phantom interest” if the next year is deflationary? For example, in 2008 inflation was +3.8%. Then, in 2009 it was -0.4%. How would you report that loss?
Granted, this is sort of a “how many angels can dance on the head of a pin” thing. But, I can remember when negative yields on TIPS was considered to be a theoretical possibility that could never really happen in the real world.
Harry Sit says
You get a negative adjustment to offset interest income in the same way positive inflation adds to your interest income. See page 12 of IRS Publication 1212.
Josie says
Hi again Harry. I just found your I-Bond & tips articles. Do you have any thoughts on buying I-Bonds vs. 5 year tips right now? I need that money in 5 years for school. Is one better than the other? Also, I bought just scheduled my Treasury purchases this morning. Thanks.
Harry Sit says
A 5-year TIPS has a higher yield than the fixed rate on I Bonds right now but it has interest rate risk. Buy it only if you’re sure you’ll hold it for five years. If you’ll need the money in year 4, a 5-year TIPS isn’t appropriate. I Bonds or a 3-year TIPS from the secondary market would be better.
Jimbo says
The question that I have is about purchasing TIPS on the secondary market. I’ll give you the following example. Today there’s a TIPS maturing in 2031 that’s going for a bond price of $86.898 with an inflation factor of 1.10543 resulting in an inflation adjusted price of $96.06.
In the unlikely event that there was inflation for the entire 9 years of the TIPS, at maturity I would receive $100, right? This is true even if the inflation factor at maturity was below the inflation factor at the time that I purchased the bond, right? For the sake of argument, let’s say the inflation factor drops to 0.90000 by the maturity date.
Instead of $90, I’d get the par value of $100 and have a net gain of $3.94. So, the only way that you can lose principal with TIPS held to maturity is by purchasing it for an inflation adjusted price over par. In theory, I supposed that’s true of re-opening auctions, too. The par floor only protects you if the inflation adjusted price is under par at purchase.
Harry Sit says
Cumulative deflation over 9 years would be unthinkable but yes, if the index ratio is below 1.0 when it matures, you’ll get $100.
Mary says
In your latest email, you mention the 10 year TIPS that you recently bought in the reopening and how you lost 4% in the next 3 days. I bought the 10 year TIPS on 7/15/22 (yield .630). At first it was gaining in value and then it started losing. As of today it is down 7%. But the current value would only be an issue if I wanted to sell it, correct? If I hold it to maturity it will still beat inflation, correct? I thought I would only see changes in the value due to interest payments and inflation/deflation adjustments. This is my first TIPS purchase so I’m still learning.
I’m planning to buy a 5 year TIPS in the October auction. It looks like the yield is going up – I’ll see how it looks right before the auction.
Harry Sit says
That’s correct. Two things are happening at the same time: (a) interest payments + inflation adjustments; and (b) changes in the going rate in the market. When you hold to maturity, you will still see price changes along the way due to (b), and conversely, seeing price changes along the way doesn’t mean you’re not getting inflation protection and the yield you bought into when it’s all said and done.
Mary says
Thanks for explaining Harry.
Chris L says
Hi Harry – I bought your TIPS book a few months back and have read through it twice. Thanks so much for writing it – it has given me a much better understanding of TIPS. I do have a few questions though if you have time.
1. Looking at VIPSX, Vanguard lists the SEC Yield right now at 1.13% . You mention in your book that this is the Real yield, and you and the notes on the website say that it is also based on the prior 30 days. Is that 30 day “lag” why the 1.13% is so much lower than the yields I see on the WSJ table market data that you reference? Right now those yields from the WSJ seem to be in the ~1.8% range (they vary by security of course).
2. Vanguard also lists a YTM for VIPSX of 3.3% on a different section of the page. That 2nd yield (the YTM) on the Vanguard website seems too high to be a Real yield – I’m guessing there is some inflation adjustments built into it?
3. If one wanted to use TIPS funds to match a future liability (you discussed this a bit with laddering), you could buy a couple of funds with different durations, so that the weighted duration of both funds were half of your investment horizon. For example, if I wanted $50,000 in Real dollars ten years from now, and assuming today’s Real yield of 1.8%, I could invest the Present Value of $41,830 into a combination of VIPSX (7.6 duration) and VTAPX (2.6 duration), at proportions that would give me a weighted duration of 5.0. And then as each year went by I could move money from VIPSX into VTAPX to shorten the duration (at 9 years do a weighted average of 4.5, 8 years a weighted average of 4.0, etc.). Would that generate the $50K Real dollars at the end of 10 years? It would be the same (same $41,830 cost to get a $50,000 return) as purchasing a 10 Year TIPS bond on the market, correct (ignoring broker fees)?
4. And if one did want to use VIPSX and VTAPX to match a future liability (barbell durations if you will), what are your thoughts once the time horizon until the liability shortens to 5 years (with the VTAPX duration of 2.6). How would you shorten up the duration as your time to the future liability shrinks from 5 years to 4 years to 3 years, etc?
Thanks Harry
Harry Sit says
When you buy a TIPS fund now, you’re buying into its underlying holdings at the yields reported on the WSJ page minus the expense ratio. You don’t need to pay much attention to the yield numbers reported by the fund.
A TIPS fund or ETF is best used for ongoing inflation protection. Most people don’t sell everything at a set time. If you do though, it’s easier to buy an individual TIPS that matures at that time. Jiggering with two funds annually is just too cumbersome for that purpose.
Chris L says
Thanks again Harry. I appreciate the reply and the information.
Marc says
I maxed out I Bonds through spousal purchasing and gifting in 2021 and 2022, thanks, in part, to your I Bond articles. Thank you, Now I’m thinking about buying TIPS with the fixed rate approaching 2%. I don’t own TIPS now. I have two questions:
1) I know you wrote a book on the subject and also recommended starting with a TIPS fund, but I was wondering what you see as the downside in buying a 5 Year TIPS directly from TD if I plan to hold it to maturity.
2) With the Fed aggressively raising interest rates, it seems that overall inflation is trending downward, albeit with inflation still elevated above historic norms. Although we can’t predict the future, this downward trend is likely to continue to some degree, which would seem to be a negative for TIPS, diminishing the principal upon which the interest rate is applied. Do you see the Fed actions as a negative for buying TIPS at this time?
Harry Sit says
If you’re sure you will hold it to maturity, there’s little downside in buying a 5-year TIPS. It’s a Treasury bond. You will get paid guaranteed principal and interest. The downside only comes when you want to sell prematurely after a rise in TIPS yield. When TIPS yields are at a 15-year high, that downside has diminished.
Negative relative to I Bonds? Lower inflation applies equally to I Bonds and TIPS with a minor difference in the lag in inflation adjustment, which has only a small effect over several years. The market is already expecting lower inflation. That’s why the 5-year breakeven inflation rate is only 2.5% at this point. As shown in the small table in this post, if the Fed is successful in getting inflation below 2.5%, you will be better off in a regular Treasury. The reason to invest in TIPS is to get a return relative to inflation no matter what. It isn’t to bet on the failure of the Fed.
John Leon says
I have never understood TIPS funds. The purpose of buying tips is to stay even with inflation, but inflation is high this year while the TIPS fund is down over 10%. Zvi Bodie appears to say this evens out over time, but does it? It seems that individual TIPS are better designed to achieve the goal, but I have read that they can be complicated to own. Please elaborate on that. Thank you.
Harry Sit says
The price of a TIPS fund comes from the prices of individual TIPS in the fund. When a TIPS fund is down over 10%, it means the individual TIPS in the fund are down 10%. If someone bought those individual TIPS some time ago, they would see a loss in their individual TIPS as well. See comment #21 for an example.
John says
Thank you for your reply. I understand that an individual tips bond can fluctuate in value, but I have the guarantee of full payment at maturity. I never have that with the fund, so isn’t the individual bond the better bet? Also, are they complicated or own in terms of taxes or administration?
Harry Sit says
It depends on what you’ll do at maturity. If you’ll spend the money or invest it in something else, an individual TIPS bond is better with the guaranteed full payment. If you’ll reinvest into another TIPS bond, it isn’t any better than a TIPS fund. In other words, a TIPS fund is better if you want TIPS as a part of your long-term portfolio for ongoing inflation protection while an individual TIPS bond is better if you want inflation protection for a pre-defined period.
Taxes on individual TIPS in a taxable account require more work than a TIPS fund. You can reduce the work by limiting your purchases to new issues at the initial auction and only holding to maturity. Reopenings and trading on the secondary market introduce more complications.
DB says
If you don’t know ahead of time if you will need the money when TIPS mature, it appears an individual bond is better than a fund as it gives you more flexibility. That is, you receive the full value at maturity and can use it for any upcoming expenses. Otherwise reinvest proceeds in another bond or something else depending on your asset allocation.
Harry Sit says
Of course nothing says you can’t do both. Invest in a TIPS fund for long-term ongoing inflation protection and buy an individual TIPS bond for planned spending or redeployment at a preset time.
George says
I am sure Harry Sit can answer this far better than I. But from my limited experience with your 2nd question, if you do your own taxes, make sure you purchase TIPS in a tax-sheltered account: both the inflation protection and the avoidance of the complex and poorly documented tax computations required will be well worth making that choice.
Austin says
So . . . after little or no research or understanding, I bought a substantial (for me) amount of the SCHP ETF at the end Sep. 2021, thinking that it was the thing to do and that it would somehow magically be protected from or ride above the coming wave of inflation. As of the end of Nov. 2022, that position is down over 15%. Looking back, it looks like I bought in way too high.
Also, I bought a substantial amount of the SRLN ETF, thinking that the combination of SCHP and SRLN was my double-whammy against inflation. SRLN is down almost 10% during the same timeframe.
But the S&P 500 is down 13-14% during that time, so maybe I’m being too hard on myself. Thoughts, anyone?
Harry Sit says
TIPS offer inflation protection over its lifetime, not a quick spike that’s expected to die after a year or two. When you bought in September 2021, the market was expecting inflation to be about 2.3% in the following 10 years. Right now the market is still expecting inflation to be about 2.3% in the next 10 years. TIPS are valued according to this expectation. It’ll be a different story if inflation stays at 8% per year for 10 years. The scenario that you bought TIPS to protect against hasn’t materialized yet.
Hongyan says
When it comes to a 529 plan, are there any special considerations when deciding between a TIPS fund vs. a non-TIPS bond fund? I wonder whether I should swap the existing non-TIPS bond fund holdings to TIPS fund. Thank you.
Joe says
Hi Harry,
I have been looking at SWRSX as a protection against inflation. Do you see it as a promising investment based on the current environment where inflation is starting to subside? I am thinking that its effective duration of about 7 years may result in nice gains if inflation does decrease. I have also been looking at IEI, which may provide some safety based on its shorter duration of under 5 years. Can you share the advantages of each based on short (3-5 years) and longer term (10+ years)? Many thanks!
Harry Sit says
Protecting against inflation means making inflation a non-issue. It doesn’t matter whether inflation is currently high, low, rising, or falling. You decide on whether to invest in a mutual fund that invests in TIPS, such as SWRSX, by whether you’re satisfied with the current yield on TIPS, which is about 1.4% above inflation.
IEI is iShares 3-7 Year Treasury Bond ETF. It doesn’t invest in TIPS. There’s no way to tell whether SWRSX or IEI will do better over either the short term or the long term. SWRSX has inflation protection but the price paid for inflation protection may turn out to be too high. IEI has no inflation protection but it doesn’t pay anything for inflation protection either.
John says
Hello again Harry – your January 16 comment above indicates that TIPS were available on that date at 1.4% above inflation. What is the rate above inflation as of today and how can we go about purchasing TIPS with that rate?
Harry Sit says
It’s still at that level. The link to the current rates is at the end of the “Higher Yield” section. The easiest way to buy is through a fund or ETF. See the “How to Invest in TIPS” section.
John says
Thank you very much for your prompt reply. I still struggle with the differences between investing in individual TIPS and IPS funds. I need to speak to an expert to clear up my confusion. If I am correct that you do not offer paid consultations, is there any advisor with TIPS expertise that you recommend?
Harry Sit says
Whether it’s better to invest through a bond fund or individual bonds depends on how fast you’ll liquidate your investment. If you’ll liquidate 100% of it at a preset time, you’re better off buying an individual bond that matures at that preset time. If you’ll liquidate 25% of it each year over four years, you’re better off buying four individual bonds that mature in each of the four years. If you’ll invest in bonds as a permanent part of your investment portfolio and only liquidate 3% of it over 30+ years, you’re better off buying a bond fund or ETF. This applies to both TIPS and non-TIPS bonds. See Two Types of Bond Ladder: When to Replace a Bond Fund or ETF.
John says
That is an excellent article thank you.
RobI says
Hi Harry
I just got my Vanguard VTAPX distribution for Q123 and its very low compared to past 6 quarters, which is unexpected when inflation is still relatively high. I see the same sort for low distribution for their ETF. Any idea why this might be?
Harry Sit says
News media usually report inflation as price changes in a one-year period — January this year over January last year, February this year over February last year. A quarterly distribution is affected by inflation during a three-month period. While the 12-month inflation was still high, inflation during the three months that drove the Q1 distribution was only 0.4%. The bulk of the 12-month inflation happened in the first nine months.
RobI says
Thanks that makes sense based on the recent CPI data… but it also makes me question the value of holding inflation based funds now. I’ll be closely watching new iBonds rate next month.
Harry Sit says
The reason to invest in inflation-protected bonds is to get the same return regardless of whether inflation is high or low. All else being equal, you want low inflation because you pay tax on inflation.
John says
Regarding the statement above that “The reason to invest in inflation-protected bonds is to get the same return regardless of whether inflation is high or low.” Are you referring to the real return? Generally speaking, most non-expert investors like me believe the reason to invest in inflation protected bonds is to get a higher nominal return when inflation increases.
Harry Sit says
Yes, the real return, after taking out inflation. If you’re happy with a 7% return when inflation is 6%, you should be happier with a 3% return when inflation is 2%. Both give 1% after inflation and you pay less in taxes in the latter case.
Audrey S says
I have heard not to invest in TIPS or TIPS funds/ETFs in a taxable account (only do it in retirement accounts). Do you have any opinion on this? Thanks.
Harry Sit says
A TIPS fund or ETF in a taxable account has the same effect on taxes as a non-TIPS bond fund in a taxable account. One can choose to invest in bond funds only in retirement accounts but that applies equally to TIPS funds/ETFs and non-TIPS bond funds/ETFs. If you’re OK with investing in non-TIPS bond funds/ETFs in a taxable account, you should also be OK with investing in TIPS funds/ETFs in a taxable account.
John L. says
Audrey: You make get a more specific response if you can state what the concern is about holding TIPS in a taxable account.
Harry: It would be helpful to talk about tax concerns that investors have about TIPS in a taxable account and explain why those concerns are unfounded, if that is the case. One common objection with respect to individual TIPS is that you must pay tax on the inflation portion of the return even though you do not receive it until maturity.
Audrey says
Yes, that is the concern (paying tax on the inflation portion even though it is not received until maturity).
Harry Sit says
That concern doesn’t apply to TIPS funds or ETFs. A TIPS fund or ETF distributes inflation adjustments as dividends.
I’m not concerned about it for individual TIPS either. Not receiving the inflation adjustment until maturity just means it’s automatically reinvested in the bonds, which is a good thing. The inflation adjustment isn’t lost. People reinvest interest and dividends all the time. That’s how you get compounding. I don’t hear anyone say reinvesting interest and dividends is a problem. We pay taxes in aggregate using income from all sources. It’s perfectly fine to pay tax on interest and dividends you reinvest.
james_077 says
Harry, July 2024 you wrote:
“IS A “TOTAL BOND” FUND STILL A GOOD CHOICE?
[https://obliviousinvestor.com/is-a-total-bond-fund-still-a-good-choice/] by
Mike Piper on _Oblivious Investor_
It is, but I’m using a “total TIPS” fund these days. See Better
Inflation Protection with TIPS”
Are you saying all your bond position is TIPS? so No nominal bond/bond funds?
Harry Sit says
By “total TIPS,” I meant a TIPS fund that invests in TIPS of all maturities. They are listed in the last table at the end of this post. I’m using one of those funds where someone would otherwise use a “Total Bond” fund. I don’t have nominal bonds or bond funds besides money market funds and T-Bills here and there for short-term spending.