Yes, real yield is important, but there are other factors to consider before making a TIPS purchase. Like: How much is this going to cost?
By David Enna, Tipswatch.com
As real yields continue to slide lower, a lot of investors are feeling a sense of urgency to build a ladder of Treasury Inflation-Protected Securities: Let’s get this done! And that means crawling through the secondary market looking for TIPS to fill year-by-year rungs of an investment ladder.
Of course, the trend of declining yields could reverse, and we could see attractive opportunities later this year. Or … we could see a repeat of 2019, when the 10-year real yield fell from 0.96% on Jan. 2 to 0.15% on Dec. 31. My thinking: This is a reasonable time to work on a TIPS ladder, if that is your goal. Real yields remain attractive, at least by the standards of the last dozen years.
I am getting a lot of questions about TIPS on the secondary market. Is real yield to maturity the only important factor to consider? Why do TIPS with similar maturity dates have different real yields? Is it bad to invest in a TIPS with a high inflation accrual? What about the coupon rate and its effect on price?
In this article I am going to run through five pairs of TIPS with the same or similar maturity dates, but in some cases vastly different up-front investment costs and slightly different real yields. Why does that happen and what is important to consider?
First, some definitions
Par value is the base amount of the TIPS you are purchasing. However, the price you actually pay is going to vary from par value. When you buy a TIPS on the secondary market, you will place a dollar amount in the order box. That is the par value you are purchasing. It is also the amount that is guaranteed to be returned at maturity, even if severe deflation sets in.
For more on the language of TIPS, see my TIPS In-Depth page.
The coupon rate is set by the original TIPS auction. It is the amount of annual interest your TIPS will earn on its inflation-adjusted principal. It is the key factor determining the cost of the TIPS on the secondary market. If the coupon rate is below market real yields for that maturity date, the price will be at a discount. If it is higher, the price of the TIPS will be at a premium.
The real yield to maturity is the amount you will earn above official U.S. inflation as long as you hold the TIPS. It is set through a combination of the coupon rate and the price you paid for the TIPS.
After you buy a TIPS, you are going to earn inflation accruals + coupon rate. That’s it. The price you originally paid — at a discount or a premium — determines your real yield to maturity. While the real yield changes minute-by-minute on the secondary market, once you make a purchase you have locked in your real yield to maturity for that TIPS.
You may see “yield to worst” quoted by the brokerage. For a TIPS, that is the real yield to maturity.
The inflation index is the current amount of accrued inflation already earned by the TIPS you are purchasing. This is stated as a number higher or lower than 1.0. If you are buying a new TIPS at auction, the inflation index is likely to be close to 1.0, or even slightly below. But a TIPS on the secondary market usually will have an inflation index above 1.0, even as high as 1.8.
The Wall Street Journal’s daily listing of TIPS values calls the inflation index “accrued principal” and shows it as a number like 1579. Your brokerage would show that as 1.57905. Vanguard calls it “factor.” Fidelity calls it “inflation factor.” What it means is that this particular TIPS has accumulated 57.9% of accrued inflation above the par value.
Adjusted principal is the amount of principal you are actually purchasing. It’s a simple calculation.
Par value x inflation factor = Adjusted principal.
For example: $10,000 par x 1.57905 = $15,790.50 adjusted principal.
Cost factor is the price you are paying for $100 of accrued principal in this TIPS. At the brokerage you will see “bid” and “ask” prices. You will probably be paying the ask price. It will look something like 97.19 for a TIPS selling at a discount or 100.81 for a TIPS selling at a premium. As I noted earlier, this cost factor is based on the coupon rate of the TIPS versus current market real yields for that maturity.
Investment cost is another simple calculation:
Adjusted principal x cost factor = Investment cost
For example: $15,790.50 x 1.0081 = $15,918.40
Note that in this calculation the cost factor is divided by 100 (100.81 / 100 = 1.0081) to reach a dollar-for-dollar multiplier.
And one more thing: Accrued interest will be added on to the investment cost at the settlement. It reflects the amount of unpaid coupon interest up to the date of the settlement. This is generally a small number, and it gets returned to the investor at the next coupon payment.
Here is an example of pricing for the Jan. 19 auction of a new 10-year TIPS, showing the interaction of these price factors:
TIPS vs TIPS: Examples
Because the Treasury used to issue 20-year TIPS (until it stopped in 2009) there are several examples of TIPS maturing on the same day in the future, but with different coupon rates, different prices, different adjusted principal and different real yields. These offer a chance to examine why real yields could vary slightly for these TIPS maturing on the same day. Is one a better investment than the other? That’s up to you to decide.
Example one: 2025
One thing to notice right away is that these two TIPS have real yields that look highly attractive, around 1.95% above inflation. But keep in mind that yields for very short-term TIPS tend to skew high. One has a coupon rate of 2.375%, so it is selling at a slight premium ($100.81), while the other has a coupon rate of 0.250%, so it is has a much lower price ($96.79).
Also notice the inflation accruals. CUSIP 912810FR4 has an inflation index of 1.57905, while CUSIP 912828H45 has an index of 1.25666. So with one you are buying $15,790 of adjusted principal and with the other, $12,566.50.
Opinion: Investors are demanding a slightly higher real yield for CUSIP 912810FR4 because of its higher inflation accrual. Remember, only the par value of $10,000 — not the $15,918.40 investment cost — is guaranteed to be returned at maturity. My opinion: I’d prefer investing in CUSIP 912828H45 and getting the additional principal at a discounted price.
Example two: 2026
This is similar to example one. CUSIP 912810FS2 has a higher coupon rate but also 49.9% extra accrued principal, versus 25.2% for CUSIP 912828N71. Investors are demanding a slightly higher yield for CUSIP 912810FS2 because of the additional principal, which will purchased at a premium price.
Opinion: Again, I would prefer investing in CUSIP 912828N71 to get the additional principal at a discounted price. Why buy additional, unprotected principal at a premium price?
Example three: 2027
Same pattern: Investors are demanding a slightly higher real yield for CUSIP 912810PS1 because of its higher inflation accrual and premium price. Investors in CUSIP 912828V49 are getting additional principal at a discounted price.
I will note that getting a coupon rate of 2.375% versus 0.375% means CUSIP 912810PS1 gets some additional protection against deflation, since the full coupon interest rate will be paid out, even if the semi-annual payments decline with declining inflation accruals. That’s one reason the real yields remain very close.
Opinion: I’d still go with CUSIP 912828V49’s lower investment cost and lower cost on the inflation accrual.
Example four: 2029
No surprise here: CUSIP 912810PZ5, with its premium price and much higher inflation accrual, gets a higher real yield than its January 2029 partner. Investors want to be compensated for the additional risk — although slight — of the higher above-par principal.
Opinion: I’d actually be a fan of buying lots of additional principal, if it was coming at a discounted price. But in this case, only CUSIP 9128285W6 fits that requirement.
Example five: 2030
Because the Treasury stopped issuing 20-year TIPS in 2009, there is only one TIPS maturing in January 2030, CUSIP 912828Z37. I am comparing it with CUSIP 912828ZZ6, a TIPS that matures six months later in July 2030. I like this comparison because these TIPS are very much alike, both with coupon rates of 0.125%.
But take a look at the inflation indexes. The older TIPS, CUSIP 912828Z37, actually has a lower inflation index that the newer TIPS, 1.15688 versus 1.16090. Why would that happen? Because CUSIP 912828Z37 was issued in January 2020 and got hit by deflationary months in November 2019 (-0.05%), December 2019 (-0.09%), March 2020 (-0.22%) and April 2020 (-0.67%).
By the time CUSIP 912828ZZ6 was issued in July 2020, that deflationary spurt was completed. So even though it has six fewer months of inflation accruals, it has a higher inflation index.
But the interesting thing is that CUSIP 912828Z37 has a higher real yield: 1.21% versus 1.16% and a lower total cost of investment in $10,000 par.
Opinion: It’s a close call, but in this case I’d prefer CUSIP 912828Z37, with its higher real yield, lower inflation accrual and lower total investment cost.
Final thoughts
Sorry for this long-winded post. I hope it doesn’t add to investor confusion. Yes, a TIPS seems like it should be a simple, no-nonsense investment, offering inflation protection and capital preservation. But the deeper you dive into the TIPS market, the more complex it seems. Questions to ask before you make a secondary market investment in a TIPS:
- How much am I actually looking to invest? For many of these TIPS, the actual investment cost will be much higher than the par value you enter when you make the order. Adjust accordingly.
- What is the market real yield for the maturity I am considering? You can check the Wall Street Journal listing to get a decent idea of current trends.
- Do I care if I am buying a substantial amount of inflation-accrued principal that is not protected against deflation? (Some investors do care; many don’t worry about it.)
- Do I care if I am paying a premium price for that inflation-accrued principal?
- Is there a reason I would prefer a higher coupon rate (at a higher cost) versus a lower coupon rate (at a lower cost)? Or vice versa?
- If I am buying a small investment, am I OK with the fact that I will probably get a lower real yield based on the bid-ask spread?
- Is a higher real yield to maturity the overriding decision-maker for you? Or do these other factors matter?
Have additional thoughts? Post them in the comments section below.
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• Upcoming schedule of TIPS auctions
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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.Please stay on topic and avoid political tirades.
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
For a TIPS investor who intends to hold until maturity, if I understand correctly, the single most important thing to consider when purchasing a TIPS is its real yield to maturity % on the purchase date because that’s the real yield % you’ll be locked into until maturity.
What I need help in understanding is does it ever make sense to churn a TIPS holding? If I bought a 10yr TIPS last year when the real yield was 1.5%, does it make sense to sell it and buy a similar TIPS on secondary market that has a current real yield of 2.1%?
Yes, there is the “cost” of the bid/ask spread, but that seems to usually be extremely small (ETrade shows only $0.12 bid/ask price spread) compared to the 10yr lifetime of benefit of earning 2.1% vs my original 1.5% real yield. So it seems like I would recoup my bid/ask “cost spread” within about 2 months given the 0.6% real yield increase.
Am I fundamentally missing something?
John, I am 100% committed to holding a TIPS to maturity, so churning is not an option for me. It doesn’t make sense to sell one TIPS with a low coupon rate to buy another of the same term with a higher coupon rate, because the market has already adjusted and these TIPS essentially offer the same real yield to maturity on the open market. The buyer of your TIPS is getting the higher real yield and you are selling that TIPS at a probable loss. So you have to make up your loss before you get any real gain from the new purchase.
I was tempted to respond to John with the same message but was smart enough to realize that David’s response will be more to the point and easier to understand….I was right…:)
Can you elaborate a little with maybe a couple of “what ifs” regarding the fact that the inflation adjusted amount is not “guaranteed at maturity?” For example, a TIP on secondary market, 10K face value, with 1.5 inflation adjustment factor, that sells for $15,000 (roughly). What risks are inherent with the $5,000 portion of this TIP? Thank you.
There is a slight risk, but it is not even close to dire. Yes, we could have a multi-year stretch of devastating deflation. In that case, nearly every financial investment would be a loser, except for nominal Treasurys. Every TIPS investment held to maturity will end up having some amount of “unprotected” accrued principal. It’s not a huge issue, but could be a short-term minor issue, in my opinion.
Thank you! I was letting this paralyze me a bit!
I am considering buying TIPS on the secondary market through Fidelity. Is the real yield to maturity an annual yield or is it for the period you hold the TIPS? I’m looking at short term holding, e.g. 4 to 8 months.
It is an annual real yield, and when the term is down to less than a year, it is an annualized real yield. So sometimes you may see some gaudy yields, but you have to remember that the yield is magnified by the short remaining term. For example CUSIP 912828B25 matures Jan 15 2024. If you purchase this TIPS you will buying 29% additional principal, at a slight discount. After that you will earn 0.625% for 7 to 8 months (so really about 0.4% on the principal) + inflation accruals for inflation through the first half of November.
An investment decision should not be based solely on cost. For your various examples (say Example 4 – 2029) with very different coupon rates, I think the interesting question is how would they perform (a) if inflation stays at current rates (b) if it falls (c) if it goes up 1%? 2%?
Since one of the reasons to buy TIPS is as inflation protection, it is important to ask what happens at various rates of inflation.
David, Thanks for all the helpful information! Now I understand how the cost of purchasing TIPS on the secondary market is calculated. However, I’d like to approach this from a different perspective: figuring out how much money I would get back. Let’s say I’m interested in CUSIP 91282CDX6, which has a maturity date of 1/15/2032 and a coupon rate of 0.125. At one point yesterday, it had an inflation factor of 1.071, a price of 88.162, and a real yield of 1.559%. If I place an order with a par value of $17,000, then the adjusted principle is $18,207 (17000 x 1.071) and my cost would be approximately $16,051 (18,207 x .88162). So, I have 3 questions: 1. How do I calculate my semi-annual coupon payments (assuming no additional inflation for simplicity)? Is it simply the adjusted principal ($18,207) times the coupon rate (0.125) times 0.5 (half a year)? 2. In addition to the semi-annual coupon payments, how much would I get back at maturity? Is it the adjusted principle ($18,207) further adjusted for any additional inflation that occurs from the time of my purchase until maturity? 3. If there is a severe depression and an extended period of deflation, what is the minimum I would get back at maturity? Is it simply par value ($17,000)? Seems like that would mean I’m already guaranteed a profit of $949 (par value minus cost) in addition to any coupon payments I receive. Thanks again for your help.
Typo here (opposite CUSIP): “But the interesting thing is that CUSIP 912828ZZ6 has a higher real yield: 1.21%”.
Great article.
Thanks for that catch. It is fixed.
Very good article, for it cleared up some of my misconceptions, but I’m not out of the woods. Perhaps you can clarify the following: “If there is cumulative deflation between the date the bond was originally issued and the date the bond matures, you will be paid more than the deflation adjusted principal value and therefore your real yield will be higher. Please note the relevant date is the original issuing date, not the date you brought the bond.”
Not sure exactly what that is getting at, but I think “originally issued date” is referring to the par value, which is guaranteed to be returned at maturity. So if deflation is so severe that the bond’s principal ends up below par value at maturity, you still get par value, and therefore you out-performed inflation (actually, deflation) while still collecting your coupon interest, and so your real yield would be higher.
I too have preferred to buy at auction largely due to getting the same price as the institutional large purchasers. BUT I wonder if some of us are overstating that advantage. I have noticed that on average the bid-ask spread for nominal treasuries and TIPS available at Schwab have typical spread of 5-6 bps (basis points) on rates, so only 0.05 percent. Sometimes this is even lower, 1-2 bps. I also note that the difference between lots sizes starting at $1,000 v $100,000 v $1,000,000 are also only a few bps different. So for treasury and TIPS I have begun to wonder whether the institutional trader is really NOT getting such better pricing than us little guys. Given the daily volatility of rates on TIPS and nominal treasuries (?treasurys) these days of more than this 5-6 bps, I am beginning to wonder if the pricing advantage of buying at auction is still relevant. There may be better bottom-line pricing by watching the secondary market for a good entry point, and accepting a few bps haircut on the bid-ask spread. Auctions have no timing control, they are scheduled, and the market is where it is (though one can see that as an advantage, to avoid thinking one can time this well).
I wonder if David Enna as a long-term watcher, and auction advocate, would comment, as well as others with experience to share.
I write a preview of every auction, and so I prefer to buy at auction since I am focused on that particular event. But in this time of better real yields, I have also been buying on the secondary market. It’s a lot of work to try to follow yields across a lot of maturity years. There really isn’t a big advantage in buying at auction, and buying on the secondary market can also backfire if yields turn against you. But on the secondary market, you do know exactly the yield you are getting. At auction, the yield could be better or worse than you expect. At an auction, everyone is equal, whether you are buying $100 (at TreasuryDirect) or $100,000 of a TIPS. It probably all balances out.
My experience: This year I have bought both at auction and on the secondary market. I’ve gotten much better prices on the secondary market, in spite of the bid-ask spread. Prices have been so volatile this year that it has paid to buy on days when there is some bad inflation news. If you buy recent issues, the accrued inflation adjustment will be negligible. How long this pattern will continue, nobody really knows.
I understand the argument about downside risk. But 15000 adjusted principal would require lots of deflation to sink back down to 10000. Do you consider how much deflation would be needed before that would happen?
If you pay $15,000 for a TIPS with a par value of $10,000, you are guaranteed to get $10,000 back at maturity. If deflation sets in, you could end up getting any amount less than $15,000 but no less than $10,000. So: $14,900, $14,500, $13,000, $12,000 etc. This risk mostly lies with very short-term TIPS.
If we bought the 10 k par tips for 15k, and deflation brought it down 10k at maturity, wouldn’t we theoritically still have the same buying power of the 15k that was invested?
More or less. Keep in mind that you would be collecting a coupon rate along the way. So you’d do a bit better. But you could have done a lot better in that scenario by buying a 10-year nominal Treasury paying 3.9%. Of course, this sort of severe deflation is almost a zero possibility.
Yes, but if instead of buying an old TIP with an accrued premium of $5,000 you could have spent $15,000 on a new issue TIP with no premium accrued yet. If deflation occurred Treasury would still pay you back $15,000 and if there had been that much deflation your buying power would have increased 50%. Each type of purchase (buying $15,000 worth of an old TIP with accrued premium already added on or buying $15,000 of a new TIP with no premium) provide the same accruals in the future (if inflation happens rather than deflation) so why take the chance on an old TIP? Always buy your TIP and your bread fresh?
As a small investor, I think your first point is critical: The prices shown at wsj.com are for institutional lots, not for people with a few thousand dollars to invest. The actual price for a small, odd lot will be much higher. The genius of being able to submit a non-competitive bid at the auction is that a small investor with as little as one thousand dollars can buy the TIP with zero transaction cost or bid-offer spread. I appreciate the challenge to building a ladder of a big gap in original issues between 10-year and 3o-year maturity. I am sure I am not alone in preferring the TIPS market be as “thick” as the Treasury Note market. However, if an investor is too old to want to buy the 30-year TIPS at auction why not just use I-Bonds for the higher rungs on the ladder? (I am a little distressed at TIPSWatch advocating short-term speculation on I-Bonds.) An I-Bond fills the ladder completely because an investor can redeem anytime between 20 years and 30 years without penalty. Plus the interest is not taxed as it accrues so it does not have the problem of phantom interest like TIPS do. (I agree with TIPSWatch that TIPS phantom interest is not economically very real but finding cashflow to pay the taxes on phantom interest can have friction too.)
If you read my writings on I Bonds, you’ll see that I always recommend I Bonds as a long-term investment, basically “until you need the money.” But I have to recognize that many people in the last year have jumped into I Bonds as a short-term investment and they will be exiting in the next 12 months, for better or worse. They should time that exit to their advantage.
I’ll be brief:
Great article !
Thank you !
I bought that 2.02% YTM TIPS last year as well. I still remember the joy upon acquiring it, and I see you do too!
With respect to the percentage of retail type investors buying from Treasury Direct or buying in the secondary market have you ever noticed how little of the TIPS are actually sold through Treasury Direct? For example, in the last auction result, the total issuance was $17,000,139,300 and there is a note that only $27,505,200 of this was through Treasury Direct. If understand this disclosure correctly that means 0.16% of the offering was sold through Treasury Direct?
Absolutely. TIPS are a big-money investment. Non-competitive bids make up a tiny share of auction purchases.
If one is interested in the highest total return from a TIPS shouldn’t real YTM be the focus, as it incorporates the two sources of return at maturity, gains in the par value from inflation and interest payments (with any adjustments for buying at discount or premium incorporated)? So by that analysis it shouldn’t matter whether you paid a premium or a discount when holding to maturity.
Instead, if your concern is the possibility of deflation eroding an adjusted principal already with significant built-in inflation, I can see that buying at discount rather than premium builds in some additional cushion.
But wouldn’t limiting purchases to bonds to lower inflation indexes already incorporated provide more deflation protection? For example I considered limiting purchases to inflation index < 1.10. But that might limit one to a very few offerings in the secondary market.
I had tried to combine those two features, low inflation index plus discounted price and found that typically limited me to just one or a few maturities.
Am I thinking about this correctly?
I think your thinking looks right. Real yield to maturity is the primary focus, and then you can weigh in factors of premium vs discounted price and the size of the inflation accrual. Last October, I bought CUSIP 912810RA8, a TIPS maturing in February 2043 with a coupon rate of 0.625% but a real yield to maturity of 2.02%. Although the inflation index was 1.289, this TIPS actually sold for less than par value because of the deeply discounted price ($76.72) at the time. This was a good combination of real yield + price, and I lucked out with that purchase, since real yields have dropped since then. https://tipswatch.com/2022/11/11/this-week-i-bought-a-historically-disastrous-tips/
Thank you for very helpful article. My question is about inflation factor. Am I interpreting it correctly, that when buying extra principal through the inflation factor, that the only guaranteed way that this may eventually be made whole is through the additional interest payments until maturity? In other words, buying $15,000 for $10,000 par value and 50% inflation factor on a 2% bond would pay approximately $300 interest payment first year after secondary market purchase (and then principal subsequently adjusted for inflation factor) instead of $200 for the $10,000 par with no inflation adjustment (for clarity of example). However, if there has not been an extended deflationary period, then is it also true that the additional principal purchased may benefit from both higher interval interest payments as well as final payment which includes the inflation adjusted principal? In other words, the risk of adding inflation factor cost is that a period of significant deflation could derail the final return if held to maturity? Again, many thanks for all that you do.
When you buy $10,000 par in a TIPS with $15,000 in inflation-adjusted principal, you immediately get that $15,000 working for you, earning the coupon rate, plus you get future inflation accruals. It all should balance out, and that is why these TIPS with the same maturity dates have very close to the same real yields.
Excellent article, as always!
One factor that is influencing ladder building (for us) is cash flow over the life of the bond and foreseeing (or trying to) opportunity to sell it before maturity. Annual income sans maturity is what we’re trying to maximize. Don’t touch the principal and all that.
If inflation and rates do drop, then for longer term bonds the value of the higher coupon should (?) keep the resale price high. In short, the yield-to-worst of a 10 year with a higher coupon sold after 7 years should (again ? lol) be higher than stated now, as the resale premium given for the coupon rate will be higher in the future as rates drop.
Or am I all wet?
Sure, the real yield to maturity is … until maturity. You can trade out of a TIPS and do better (or worse) because of market fluctuations. In that case, some of the difference could be a capital gain or loss, but I am no tax expert.
Superb! Very helpful walkthrough of considerations for evaluating TIPS in secondary market. Thank you so much!!!
Thank you for reminding me why I prefer buying at auction when possible. 👍
But for the secondary market…Does having an choice between buying in a tax-deferred vs taxable account nudge these considerations in any direction?
Interesting question. I have heard from some readers who look for very low coupon rates (such as 0.125%) when they are buying in a taxable account. That minimizes the taxes due each year.
I think this is a critical issue. Low coupons mean low taxes annually. On the other hand, if by “low coupon” we mean a coupon reflecting lower real yields at the time of issue versus today, the bonds will sell at a discount and the investor will owe capital gains taxes at maturity. A high-coupon bond trading at a premium will result in a capital loss at maturity. So I want a high-coupon bond. Or?
No, not confusing at all. Your articles are the only ones about TIPS that clearly spell out all the different “components” of TIPS.
Excellent article and examples on buy TIPS in the secondary market. Thanks for posting all your articles and providing education on TIPS and I-Bonds. I have purchased a couple of books on TIPS investing and none come close the providing the same quality of education.