Newspaper article Sarasota Herald Tribune

Do Treasury Inflation-Indexed Securities Make Sense Today?

Newspaper article Sarasota Herald Tribune

Do Treasury Inflation-Indexed Securities Make Sense Today?

Article excerpt

TREASURY INFLATION-PROTECTed securities, more commonly called TIPS, are complex securities backed by the "full faith and credit" of the U.S. government. As their name suggests, they offer investors protection against rising prices.

I became a fan of these more than a decade ago when I purchased TIPS with a 10-year maturity and a coupon (interest-rate) of 3.375 percent. At that time the purchase was almost a "no-brainer" for older, moderately conservative investors and retirees.

Why? Recall that one guideline for withdrawing from a retirement portfolio with a low risk of depleting it before death is to initially withdraw no more than 4 percent and increase this each year by inflation. As we will see, the ways TIPS work made those TIPS almost an ideal investment for part of a retirement portfolio.

Before analyzing if TIPS make as much sense today, let's examine how these bonds work to protect against inflation as measured by the consumer price index.

Recently, 10-year TIPS were yielding about . 9 percent plus inflation. For simplicity, suppose that an investor bought $10,000 worth of 10-year TIPS at par with a . 9 percent interest-rate and that inflation averaged 2 percent annually. This is about what the market is forecasting for the CPI over the next 10 years.

After six months, the investor would receive $45 in interest. Since inflation for six months was 1 percent, the principal amount of the bond would be increased to $10,100. The interest that the investor received the next six months would be $45.45 because it would be based on the increased principal.

This adjustment to principal and interest would occur every six months for the life of the TIPS. At the end of 10 years, the government would redeem the TIPS for about $12,202, based on the 10 years of 2 percent inflation. The last six-month interest payment would be about $54.

Compare this to my $10,000 TIPS: My first interest payment was about $169. Since inflation for my TIPS was about the same, my bond was redeemed for a similar amount. However, my final interest payment was about $204.

Readers are probably seeing the problem here: While protecting your principal against inflation, the current low interest rate provides little cash to spend. …

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