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TIPS may or may not fit into your overall financial plan.
Key points
Treasury Inflation Protected Securities are designed to hedge against inflation. TIPS are backed by the federal government, but the interest rate is variable. TIPS have expiration dates of 5, 10, or 30 years.
If rising interest rates have you out of breath, you may be looking for a safe place to protect your cash. If so, Treasury Inflation Protected Securities (TIPS) are worth considering. However, before you do anything, make sure you understand the good, bad, and ugly features of investing in TIPS.
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1. Understand how TIPS work
TIPS are a type of Treasury security. Unlike other values, however, the principal is not fixed. That means that the principal can go up or down over time. Still, because they are backed by the federal government, TIPS are considered a safe haven for investors looking to protect money from inflation.
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The TIPS interest rate is fixed every six months until maturity in 5, 10 or 30 years. Interest rate adjustments are based on a version of the Consumer Price Index provided by the Bureau of Labor Statistics. TIPS can be held until expiration or sold before that time.
When TIPS expire, if the principal is higher than the amount you originally invested, you will receive the higher amount. If it is equal to or less than your initial investment, you receive your initial investment back.
2. Familiarize yourself with the pros and cons
Like all investments, TIPS has attractive and less attractive features.
advantages
Because they are backed by the US government, TIPS are a low-risk investment. TIPS protect investors from losing their money. They may not earn much, but they won’t lose value. TIPS help people on a fixed income protect their purchasing power.
cons
TIPS almost always pay a lower interest rate than other securities. Interest earned on TIPS is taxable, even if the investor does not know how their investment performed to maturity. TIPS do not provide actual income like an annuity or other investment. Even financial experts have trouble determining why the actual performance of TIPS moves.
3. They can hedge against inflation, but TIPS are ill-tempered financial instruments
Due to fluctuating interest rates, TIPS returns are notoriously volatile. For example, according to Morningstar, medium-term TIPS fell 12% in 2022.
However, that is not always the story. TIPS have occasionally represented a more compelling investment option than their Treasury competitors. It’s that “will they or won’t they” that makes TIPS somewhat erratic.
4. The fall of 2022 may represent an opportunity
Despite the ups and downs of TIPS, you always know that you will walk away with at least your original investment while keeping pace with inflation. You may not beat inflation, but it won’t overwhelm you either.
While a 12% drop in 2022 sounds scarier than attending a wedding in your underwear, the drop means you can park your cash on a cheaper TIPS bond. While others are running out the door, you can sneak in and grab a bargain. As Warren Buffett says, we should “only be greedy when others are afraid.”
Sure, there are more attractive investments out there, but few that will shield you from the real worry of inflation. This is a quality that TIPS have going for them.
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Source: news.google.com