What Are Treasury Inflation-Protected Securities All About? - dummies

What Are Treasury Inflation-Protected Securities All About?

Treasury Inflation-Protected Securities (TIPS) receive both interest and a twice-yearly increase in principal for inflation. As with interest on other Treasury securities, interest on TIPS is free from state and local income taxes. Federal income tax, however, must be paid each year on both the interest payments and the growth in principal.

TIPS are transferable. You can buy TIPS directly from the Treasury or through a broker. They are currently being issued with terms of 5 and 10 years, although there are plenty of 20-year term TIPS in circulation. The minimum investment is $1,000.

One of the sweet things about TIPS is that if inflation goes on a rampage, your principal moves north right along with it. If deflation, a lowering of prices, occurs (which it hasn’t since the 1930s), you won’t get any inflation adjustment, but you won’t get a deflation adjustment, either. You’ll get back at least the face value of the bond.

TIPS sound great, and in many ways they are. But be aware that the coupon rate on TIPS varies with market conditions and tends to be minimal — perhaps a couple of percentage points. If inflation is calmer than expected moving into the future, you will almost certainly do better with traditional Treasuries. If inflation turns out to be higher than expected, your TIPS will be the stars of your fixed-income portfolio.