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.
Treasury Inflation-Protected Securities 
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You are right, the coupon is 3.875%, my mistake. Are you seeing a quote of $229.97 in a brokerage account? On the secondary market, I am seeing a current price of $163.02 for $100 of value for that TIPS, but it could be the price you are seeing includes accrued principal (the inflation adjustment), which would add another 40%, or about $228, pretty close to that quote. If you sold today you would get $228, including that accrued principal.
The buyer would be paying $163 per $100 of value for a 16-year TIPS, resulting in a yield to maturity of -0.075% at current prices. (Roughly … 3.95% in extra interest for 16 years = 63%)
thanks!!
yes, this was a quote from my Schwab acct
and the inflation adjustment is 1.41297
here is some more ‘math’ on this question?
I agree that if you use $3.875 as the PMT in the IRR calculation and $100 as the par value you get a yield to maturity of -.0468% over 16 years
However the coupon rate on the TIP is ‘paid/accrued’ on the inflated value of the Bond not on the par value of $100
adjusting the PMT by the current inflation factor of 1.4129 you get an adjusted PMT of $5.4753
this would result in a IRR of +1.440% over 16 years
and that calculation assumes NO further increases in the inflation factor
Did I do the ‘math’ correctly ? ? ?
Grant, I am still holding mine, but I always hold TIPS to maturity. You can get a very good price on the secondary market, about $156 for $100 of value. It currently has a yield of -0.138% with a coupon rate of 3.625%, meaning buyers will have to pay a big premium for it. By selling, you would be collecting that future interest in one swoop. Big question: Where would you put the money?
my TIP has a coupon of 3.8750 and a price of $229.9727. how does that give a yield of -0.138% ?
I purchased this very tip in 1999 912810FH6 and still hold it
it has been a great investment
Should I keep it after holding it for 14 years???
As I tell everyone who asks me about TIPS, you can ONLY buy TODAY’S yield and not yesterdays yield. I believe for the invdividual investor buying a TIP bond with a negative real yield is insane. I believe one should only buy these with positive real yields. Another strategy one could do is after maxing the i bonds, put the money into EE bonds because if there is a lot of inflation, there is a good put option where you can cash out the EE bonds for TIPS, but if there is no inflation you could get 3.53% yearly compounded if you keep the EE bonds for 20 years. Just an interesting thought I just had as far as a strategy to fight inflation and deflation. Thoughts?
Joe, I agree that EE Bonds make a lot of sense as an alternative to longer-term Treasuries. If you sell in 5-10 years, your return will be negligible (0.6%), but that’s also the case with Treasuries, with a 5-year Treasury paying a very similar 0.7%. Plus, taxes are deferred on the EE Bonds, and earnings are reinvested. I disagree on buying a TIPS with a negative real return. I’d be willing to go with a 5-year TIPS paying maybe -0.5%, but today’s rate of -1.608% is ghastly. Some investor theorize it’s better to accept poor returns in the short term, and then reinvest later at better rates.
Isn’t it interesting that a 10-year traditional Treasury at 3.0% seems like a radical idea? In reality, without the massive Fed manipulation of the Treasury market, the 10 year would easily be 3% today. In that real world, figuring 2.5% inflation over the next 10 years, TIPS would be yielding about 1%, plus inflation. That is the real world. We don’t live in the real world in 2012.
Bill, I agree that laddering is really the only way to buy TIPS. No one should be dropping a huge hunk of their nest egg into a specific TIPS right now, and definitely not into a TIPS mutual fund. Laddering TIPS is an extremely conservative, and safe, way to preserve capital. It’s looking like Thursday’s 10-year reissue could go off at about. -0.75%, which would be a record low. At the same time, the 10-year traditional Treasury is well off its low, yielding about 1.85%. The two yields are moving in opposite directions. If the 10-year traditional keeps rising, the 10-year TIPS yield will also rise, eventually. But who knows?
One of the things I read into the QE3 announcement is that the Fed wants to increase the inflation expectations — by saying they’ll keep rates low for some period after the economy recovers. Of course Fed announcements never include target numbers, so we’ll have to watch the breakeven rate to see where it stabilizes. My guess is the spread will rise, and the 10-year traditional will have to get up to 3.0% before we see positive TIPS auctions. I hope we don’t have to wait until 2015 for that to happen.
Are all TIPS mutual funds managed the same way?
Peter, there do appear to be only slight differences in the major TIPS funds. I have seen tiny differences in duration, which means some funds are moving to shorter-term or longer-term TIPS investments. But the major funds perform pretty similarly. The major ones are the TIP ETF, with a year to date capital return of 5.48%; the Vanguard Inflation-Protected Secs Inv (VIPSX), up 5.65%; and the Fidelity Inflation-Protected Bond (FINPX), up 5.46%. Those are very similar returns. There are other TIPS funds out there that specialize in shorter-term, or longer-term, and some international inflation-adjusted funds, too.
I think there is another case to still buy TIPS, even at the current rotten yields — laddering. In my retirement savings, I’m building a ladder of 10-yr TIPS. In any bond ladder, there will be rungs with good yields, and rungs with bad yields. Hopefully over 10 years the average will be decent. The decision with each TIPS auction that I struggle with is whether to skip a ladder rung, in the hope of (1) getting a reasonable yield on the funds with another investment, and (2) filling in the rung from the secondary market later. I don’t know where the threshold is for me to skip a rung, but -0.6% has not been bad enough.