There continues to be a lot of movement in interest rates on savings accounts, certificates of deposit and other cash equivalents. I think the most interesting corner right now is the rise in real yields on TIPS (Treasury Inflation-Protected Securities) and their relationship to traditional Treasuries. About 1/3 of my bond allocation is for TIPS.
TIPS can be a bit tricky, but they are basically priced based on their actual performance. As of 09/26/22, the actual closing yield on a 5-year TIPS was 1.82%. This is the highest real return since the 2008 financial crisis and we have been in negative returns for much of the last decade. (Source: FRED)
(As an inflation-linked bond, a TIPS with a real return of 1.82% means that if the CPI-U inflation is 3%, its total return will be 4.82%. “Real” means after adjusting Thus, TIPS “protects” you from unexpectedly high inflation. If inflation ends up at 10%, you will earn 11.82%. However, if inflation is very low, your return will also suffer. affected in the opposite direction).
As of 09/26/22, the nominal closing yield on a regular 5-year Treasury bond was 4.15%. That means the 5-year “break-even” rate of inflation was 2.33%. If you bought equal amounts of 5-year Treasuries and 5-year TIPS today, the winner after 5 years will depend on whether the future inflation rate ends up being above or below 2.33% over the next 5 years. This creates a market-based estimate of future inflation rates. Here is the 5-year historical equilibrium inflation rate for the last 10 years:
Looking back, TIPS underperformed regular Treasuries for 11 of the 16 10-year periods ending 2013-2021, as inflation was generally lower than the breakeven rate. Image credit to TIPSWatch.
At this moment there are CD’s negotiated at 5 years at 4.20% (non-callable) and the Treasury at 5 years at 4.15%. Purely my opinion, but I would consider 5Y TIPS over both options as I like the combination of a decent real rate of 1.83% and a modest 2.33% breakeven rate. I would risk underperforming regular Treasuries for a bit in exchange for insurance against high inflation. This is why I usually have a mix of TIPs and Treasuries for my portfolio’s bond allocation.
Note that the current I Savings Bonds only have a real rate of 0% and we will see how much they increase it in November (my bet: not as much as the 5Y TIPS). So TIPS would even outperform savings bonds at this point in my book (as long-term bond holdings). However, the situation changes daily and I don’t know what rates will look like when you have a significant amount of cash available to reinvest.
Source: news.google.com