Brett Arends of MarketWatch.com wrote an ROI column this week sharply criticizing TIPS and the ‘suckers’ who buy them. Great headline: ‘Holding TIPS will make you poorer.’
Would you buy an investment that was absolutely guaranteed to lose money? No ifs, ands or buts: This sucker will make you poorer! How’s that sound? You might think this is a crazy question. You’re probably thinking, who would choose to own an investment that is guaranteed to lose money?
Arends argues that buying a 10-year TIPS with a base interest rate of less than 1% – or a 5-year with a base yield dipping into the negative – is ‘crazy, totally nuts.’ He also points out that the Consumer Price Index is a lousy way to measure inflation.
I agree with and understand his points.
Would you rather buy a 5-year CD at the local bank, now paying about 2.4%, or have a Treasury instrument (no state income taxes) that pays the rate of inflation minus 0.18% (the rate of the last 5-year auction)? At the least, it is a tossup, since the TIPS has inflation protection and the CD doesn’t.
Would you rather buy a conventional 5-year Treasury today, now paying an absurd 1.78%? That is an easy choice: I would go with the TIPS in this case. The inflation protection is a lot more valuable than getting 1.78% on your money, which is highly likely to produce a real return well below the -0.18% of the April 5-year TIPS.
(I contend that for a small investor, the U.S. I Bond is a better investment for your first $5,000 invested, since its base yield is locked at zero and it offers the same inflation protection. Zero is better than negative.)
The reason TIPS yields have gone negative is because the conventional Treasury yields have dipped to extreme lows, well below the likely rate of inflation over the next 5 years. So there is some logic to buying TIPS, to capture the rate of inflation (even at a slight penalty).
But I agree: Buying TIPS and holding them to maturity is not a ‘fabulous’ investment right now. It is OK. It is safe. It is a do-it-and-forget-it investment. (But I definitely would not dump a major portion of a portfolio into TIPS at the moment.)
And TIPS mutual funds are risky. Eventually the base rate on TIPS is going to climb back toward the historical yield of 2%, and TIPS mutual funds will get clobbered.