I get that question a lot. My quickest reaction is: ‘No.’ Treasury Inflation-Protected Securities were a really good investment back in 1999, when you could have bought a 30-year TIPS with a yield to maturity of 4.138% – that means 4.138% above the rate of inflation until 2029. That wasn’t just good, it was magnificent. It was auctioned Oct. 6, 1999.
In the 1990s, TIPS were an unknown product and the stock market was booming. No one was really considering TIPS and they were unloved. That resulted in some great buying opportunities:
That was then, and now? In 2012, TIPS are very much loved. And buyers are paying for that love. So much so that that the yield to maturity on CUSIP 912810FH6, which I praised above, is now -0.067% on the secondary market. This magnificent creature of 1999 is now a shriveled-up 17-year TIPS with a return that is negative to inflation. It isn’t pretty.
Why are TIPS so loved? TIPS and US Savings I Bonds are the only two investments on Earth that are 1) super safe, and 2) reward the investor for unexpected inflation. When investors feel fear, #1 is appealing. And when investors fear inflation, #2 is appealing. Right now, investors feel both fear and fear of inflation. That has driven TIPS yields to extremely low levels, negative to inflation well up the maturity ladder.
Other investments are super safe: Traditional Treasuries, of course, and Bank CDs with FDIC or NCUA insurance. But they also currently offer returns well below the rate of inflation, which let’s just round up to 2% currently. A 5-year Treasury pays 0.72% today, and a 5-year bank CD pays about 1.7%. A 5-year TIPS pays about -1.691% (plus inflation), which is extraordinarily low.
In rejecting that 5-year CD, a buyer of a 5-year TIPS is betting that inflation will average 3.39% over the next five years. Does that bet make sense at a time of muted inflation and very low economic growth? You’d have to fear something to make that bet.
On the other hand, world banks, huge hedge funds and multibillionaires can’t be investing in insured bank CDs. They are stuck with that 5-year Treasury as a super-safe choice, and then the breakeven inflation rate falls to a more reasonable 2.41%. If I was investing millions, I’d probably want that inflation protection.
So, are TIPS are good investment in 2012? Yes, if you happen to be a world bank, pension fund or hedge fund.
There is logic to the pricing of TIPS. But that logic doesn’t work as well for the small investor in September 2012. (By far, the best super-safe investment for the small investor is the I Bond, which pays the rate of inflation, minus nothing. You can sell it after five years with no penalty. But you can only buy $10,000 per year, per person.)
Who should buy TIPS? In 2012 – at these rates – TIPS are all about capital preservation. There is really no other reason to purchase them. Most likely, the return will be very low. The buyer will get his money back, absolutely. But TIPS and I Bonds are a vehicle for protecting your nest egg from the disaster of inflation.
Capital preservation means you probably have 1) a very large nest egg and 2) are nearing retirement or already retired. If both of those cases are true, I can still see TIPS as a reasonable investment in 2012. Inflation might be your worst enemy, and you should design your portfolio to protect against it.
For you, my suggestion for asset allocation is something like: 1) 25% in super safe investments like TIPS, I Bonds and bank CDS, 2) 25% in low-fee bond funds, 30% in dividend-paying stocks and index funds, and 20% in international stock and bond funds.
(Do I need to remind you that I am a journalist and not a financial adviser? That’s just my suggestion, nothing more.)
But I am young and just starting out investing! Well, the bad news is that TIPS are going to be a lousy investment. Seriously. You have to build wealth before you worry about capital presevation. In 1999, with TIPS paying 4% above the inflation rate, there was an unusual buying opportunity. That does not exist today. TIPS are expensive.
Should I sell my TIPS and TIPS funds? I am strictly a buy and hold investor in TIPS. I have never sold a single purchase, going back 13 years. That is my style, but it might not be yours. TIPS have had a tremendous run, accelerating in mid 2011, as the Federal Reserve pumped massive amounts of cash into the money supply.
Some people might want to take profits. If you do, ask yourself this: Where will I put this money? Will it be in a similarly safe investment? Will the money be earning zero percent in a money market fund for two years? Will I be changing my asset allocation?
Of course, parking the money might work, if the TIPS juggernaut somehow loses steam.