David Enna, Tipswatch.com

On October 21, 2021, the Treasury offered $19 billion in a new 5-year Treasury Inflation-Protected Security, CUSIP 91282CDC2, generating the lowest real yield at auction in the 29-year history of this investment, -1.685%. These were very dark days for investors in TIPS.

In my recap of this auction, I wrote:

The auction result doesn’t mean that investors were accepting a negative nominal return, but they were willing to pay a 9% premium to par value to collect a 0.125% coupon rate plus five years of inflation accruals. To put this another way, official U.S. inflation will have to increase about 9% before investors reach a breakeven point on this investment.

That is actually scary. But you know what? CUSIP 91282CDC2 ended up being a decent investment, at least versus the nominal 5-year Treasury available in October 2021. Here is the final tally for this 5-year TIPS:

Note the nominal return in the final column: 2.375%. In October 2021, a 5-year Treasury note was yielding 1.20%. Over the ensuing 5 years, inflation ended up running at an annual rate of 4.1% (rounded) versus the auction’s inflation breakeven rate of 2.89%. The result is that the TIPS outperformed the Treasury note by a wide margin, as has been the case for all TIPS maturing in recent years.

This reinforces a simple point: A TIPS will out-perform a nominal Treasury of the same term when inflation runs higher than expected. Inflation has been running much higher (4.1%) than expected over the last five years. Over the last decade, inflation-breakeven rates for TIPS have rarely exceeded 2.5%, and often were much lower.

This auction was unique because the real yield was deeply negative and the inflation breakeven rate was unusually high (2.89%), and the TIPS still outperformed.

I Bonds were the winner

In my preview of the 2021 auction, I noted that I Bonds (with a 0.0% fixed rate at the time) were a much more attractive investment. The math is simple: The I Bond would match official U.S. inflation while the TIPS would trail inflation by 1.685%. I wrote:

For a small-scale investor, in October 2021, an I Bond makes a heck of a lot more sense than a comparable TIPS.

The October 2021 I Bond — with a 0.0% fixed rate — has had about a 4.3% compounded rate of annual return over five years, much better than 2.375% for the TIPS and 1.20% for the Treasury note. (Source: Eyebonds.info)

What about bond funds?

• Vanguard’s Total Bond Fund (BND) has had a total annual return of -0.29% over the last five years. Ouch.
• The iShares TIPS ETF (TIP), which holds the full range of maturities, has had a total annual return of -0.05% over the last five years. Also ouch.
• Vanguard’s Short-Term TIPS ETF (VTIP), which holds TIPS with maturities less than five years, looks better with a total 5-year annual return of 2.93%, better than the October 2021 TIPS (2.375%) but worse than the I Bond at 4.3%.

Bond funds had been doing a bit better going into 2026, but the sharp rise in longer-term yields has hit full-maturity-spectrum funds hard.

Thoughts

Two very important takeaways: 1) An I Bond — even with a fixed rate of 0.0% — will be an attractive investment any time the Federal Reserve decides to repress interest rates through quantitative easing. And 2) Even a TIPS with a negative real yield can be “relatively” attractive if the inflation breakeven rate is lower than seems likely.

Notes and qualifications

My TIPS vs. Nominals chart is an estimate of performance.

Keep in mind that interest on a nominal Treasury and the TIPS coupon rate is paid out as current-year income and not reinvested. So in the case of a nominal Treasury, the interest earned could be reinvested elsewhere, which would potentially boost the gain. For certain, we don’t know what the investor could have earned precisely on an investment after re-investments.

In the case of a TIPS, the inflation adjustment compounds over time, and that will give TIPS a slight boost in return that isn’t reflected in the “average inflation” numbers presented in the chart.

• 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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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.