A little story. Back in 1999 I was at a cocktail party, and of course, the conversation drifted toward the red-hot stock market, as it always did in 1999. What were you buying? Cisco? AOL? Something-or-other.com?
I said, “I’ve been looking at TIPS, Treasury Inflation-Protected Securites.”
Blank stare from the group standing around me, which included several investment professionals.
“No really, TIPS are paying 4% above inflation and are rock-sold safe. Where can you find another investment like that?”
Blank stare. Oh well, change subject.
I did end up buying TIPS that year, and every year since, directly through TreasuryDirect.gov. Those TIPS I bought in the late 1990s were fantastic investments, returning 3 to 4% above inflation while the stock market had a negative real return over the same time.
Sure, I had money in the stock market, too. But the TIPS investments were sort of ballast for my financial ship. That investment was not going down. That investment was 100% safe.
So today, TIPS are nowhere near as appealing, paying around 0.9% above inflation for a 10-year issue. And this is at a time that the stock market seems pretty fairly valued. And yet TIPS are now massively popular — go figure.
The reason is: The risk of inflation is lurking. If it strikes, and I think it will, your regular bond investments (especially in mutual funds) are going to take a big hit. TIPS mutual funds will also be hit — be sure of that.
My premise is to buy and hold TIPS directly from the Treasury and hold them to maturity. It is not a sexy strategy. But is a safe strategy, if you build a collection of these investments over time. And you invest only up to 25% of your portfolio this way, meaning you keep stock market exposure, and some CDs, bond funds, etc.
The big negative is that you pay tax on the inflation-adjusted principal — I’ll talk about that later.
NOTE: I am just an investor, not a financial professional. I am not selling anything, and my financial advice is just my personal opinion. I am sure many will disagree, and I hope you make your voices heard.
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Last week I placed an order through Fidelity to buy the 5 year TIPS with the auction date of 04/21/11. I plan on holding to maturity.
This morning, the pending order was no longer showing in my Fidelity account. When I called, Fidelity informed me that all 5-year TIPS open orders for Fidelity customers have been canceled beccause of the expected high negative yield. Fidelity expects the purchase price to be at 1.02 of par with a nominal interest rate of 0.125% resulting in a negative yield of -0.78%. With the current 5-year bond yield at 2.2%, you would need an inflation rate of approx. 3% to break even on the TIPS. Do you agree with Fidelity’s calculations and do you still plan on making a purchase. Thanks. I’m glad I found your blog.
As of Friday, April 15, the 5-year TIPS yield was around -0.264%, putting the break-even rate around 2.4% (the five-year Treasury yield dropped to 2.14% on Friday). But this looks pretty volatile. A TIPS maturing in January 2015 was yielding -0.792, right around what Fidelity was predicting. I am wavering on a purchase. Inflation expectations are suddenly soaring just as this issue is being auctioned, so people are speculating that inflation will overtake a negative yield. It could, but it makes this issue less attractive.