By David Enna, Tipswatch.com

One morning last week on Bloomberg, a fixed-income analyst was asked about the effect of a 5% nominal yield on a 30-year Treasury bond. He said: “Then you’ll see bond investors attacking like seagulls in Finding Nemo.” (See Nemo video)

I must have seagull instincts. A 30-year nominal cracking 5% doesn’t particularly interest me, but I was curious about real yields for the top end of my ladder of Treasury Inflation-Protected Securities, years 2040 to 2043.

So I flocked in. When I built this ladder, mostly in late summer/fall of 2023, I didn’t quite fill out the years 2041 to 2043, mainly because of very high existing inflation accruals on those TIPS, which means buying a lot of additional principal.

In mid-April and then last week, I completed the top end. I thought it would be helpful for me to explain how each transaction worked.

April 14: CUSIP 912810QP6

This TIPS matures Feb. 15, 2041. I own one portion at TreasuryDirect (bought at the original 2011 auction with a real yield of 2.190%) and another portion in a traditional IRA, bought in fall 2023 with real yields of around 2.20%.

• Par value: $7,000
• Coupon rate: 2.125%
• Inflation factor: 1.4885
• Adjusted principal: $10,419.50
• Price: 98.27343
• Cost of investment: $10,239.60
• Real yield to maturity: 2.263%

For this purchase, I was looking to add $10,000 to 2041’s accrued principal, bringing it to my target level for each year of the ladder. Because of the large inflation accrual, I placed a par-value order for $7,000 to get the result of $10,419.50 in adjusted principal, at a cost of $10,239.60.

I like this TIPS, which I will hold to maturity, because I appreciate having a 2.125% coupon rate creating cash flow through the next 15 years. The next two TIPS don’t have that same coupon-rate advantage, however.

May 5: CUSIP 912810QV3

This TIPS matures Feb. 15, 2042.

• Par value: $8,000
• Coupon rate: 0.750%
• Inflation factor: 1.448665
• Adjusted principal: $11,589.20
• Price: 77.57812
• Cost of investment: $8,990.68
• Real yield to maturity: 2.475%

I spent $8,990.68 to add $11,589.20 in principal, bringing the total to my goal. The yearly cash flow isn’t great at 0.750%, but this is the way it works — there is only one TIPS maturing in 2042. This is the only option. The real yield to maturity of 2.475% was well above my original 2023 purchase at 2.105%.

May 5: CUSIP 912810RA8

This TIPS matures Feb. 15, 2043.

• Par value: $10,000
• Coupon rate: 0.625%
• Inflation factor: 1.42376
• Adjusted principal: $14,237.60
• Price: 74.14843
• Cost of investment: $10,556.96
• Real yield to maturity: 2.525%

This TIPS had the biggest gap to my yearly target amount, so I was looking to add $14,000 in principal, which required purchasing $10,000 par value at a cost of $10,556.96. The real yield of 2.525% was well above my 2023 purchase at 2.203%.

Deflation risk?

I get a lot of feedback from readers who are very resistant to purchasing inflation-adjusted principal above par value, even at a discount. The reason: A TIPS is guaranteed to return only par value at maturity, and that means any amount above par value is exposed to risk of deflation, meaning principal would decline.

Yes, it is a risk. But as I noted in this article, “Don’t over-think the potential threat of deflation,” the risk is much greater short-term than long-term.

Since 1971, the lowest average annual inflation for any 5-year period was 1.4%, for the 5 years ending in both 2017 and 2018. For 10-year periods, the lowest was 1.6%, for the years ending in 2017. For a 30-year period, the lowest was 2.2%, for the years ending in 2020.

So if you are buying a TIPS on the secondary market with a high inflation index and 15 years remaining to maturity, you can be fairly confident you won’t be struck by a 15-year period of deflation, eating away at your above-par investment.

Since 1971, there has not been a single deflationary year ending in December. The lowest inflation rate was 0.1% in 2008.

And keep in mind that every single TIPS you are holding at the moment has an inflation accrual above par value.

Sense of completion

These are fairly small investments, not life-changing in any way. The three purchases will allow me to focus on future purchases of TIPS maturing in 2037 to 2038.

Last week, I had an interesting question from a reader:

In deciding upon the ending year for your target range do you include additional years your beneficiary may hold the account after your own death? I am currently thinking for TIPS held in a Roth wrapper account that 10 years beyond my expected death would be a reasonable year to select and that a 10 year rolling TIPS ladder could be a great fit and allow the beneficiary to hold all the TIPS in the Roth account to maturity if they wish.

I can’t argue with that premise, as long as the beneficiary is a responsible person who could take directions and understand how TIPS work. My wife and I have no children, so beneficiaries aren’t a great concern.

Will I live to that last maturity in 2043, when I will be just months from 90? It’s certainly possible, but maybe not likely. I definitely think my wife could live to 90 and she has financial smarts. But around age 90, who wants to be managing a TIPS ladder?

Let’s face it: TIPS are a complex and intimidating investment. I was talking to a Wall Street Journal reporter a week ago who told me that a co-worker, very skilled at financial journalism, doesn’t get TIPS at all. We laughed. But that’s the norm. I hope this article provides helpful information on purchasing TIPS on the secondary market.

The complicated nature of TIPS is why a lot of sophisticated investors prefer I Bonds, despite the lower real yield. I Bonds have advantages of tax-deferral, rock-solid deflation protection, and a flexible maturity. They can never go down in value, unlike a TIPS. I Bonds and TIPS make a good combination.

Here is the Wall Street Journal video:

• Now is an ideal time to build a TIPS ladder

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• TIPS investor: Don’t over-think the threat of deflation

• 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. NOTE: Comment threads can only be three responses deep. If you see that you cannot respond, create a new comment and reference the topic.

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.