Treasury Inflation Protected Securities, in short TIPS promising a risk free investment for the people of United States. As the name suggest, the main purpose of Treasury Inflation Protected Securities is to protect your investment from the inflation.
But are TIPS the best option for this purpose or should you consider other security instruments to protect your investments? This is a question that needs to answered. Just take a look at the delegate characteristic of Treasury Inflation Protected Securities, these are the only kind of assets that increase and decrease their value in response to the rate of inflation, which affects the real buying power of the person.
As the only way to fight off inflation is to impose certain theoretical measures, thus, investors have newly flocked to TIPS as a result of the fear of the rising inflation rate clarify by the price surge in 2022. Although TIPS may indeed counteract some of the price increases of inflation, they include and expose investors to their own set of risks and challenges.
How Treasury Inflation Protected Securities (TIPS) Work
TIPS are government securities whose principal value is indexed to the Consumer Price Index (CPI) with the purpose of keeping pace with the inflation rate. TIPS rising in value means that they can facilitate your purchasing power, assisting you in not to lose money. For example, if you have a TIPS bond with a face value of $1,000 and the CPI increases by 3% over the year, the principal of your bond will rise to $1,030. The increased principal guarantees that the interest payments you get are based on the updated principal, so you are protected
Notwithstanding the fact that Treasury Inflation Protected Securities (TIPS) have a number of positive factors, they have their setbacks as well. First and foremost, their price is still dependent on the bond market volatility. Though TIPS are not that volatile like share market, as some other bonds are, still, their prices may change, especially when there are periods of interest rate changes. Secondly, there are those times when the actual real yield of TIPS could be lower than the one estimated during the calculation due to economic turmoil.
Considerations Before Investing in TIPS
Moreover, to invest in TIPS, there are some essential points to consider. One key point is that TIPS are mainly beneficial when held to maturity. If you dispose of your Treasury Inflation Protected Securities before maturity, you may get more or less money than you expect based on current inflation forecasts. Moreover, although TIPS carry tax benefits at the local and state levels, the interest income is still taxable under the federal law. This particular tax feature of TIPS makes them an excellent investment tool for IRA accounts.
One more thing for your attention is the risk of deflation. There is only a rare chance of deflation happening, but if it occurs, TIPS, which are debt securities indexed to inflation, will in value. If the Consumer Price Index goes down, the principal of your Treasury Inflation Protected Securities bond will also decrease, but still, you will receive at least the original face value of the bond at maturity.
Are TIPS Right for Your Portfolio?
Aside from inflation, TIPS can be a good investment tool to include in your portfolio as a means to hedge against it. They offer a sure way to protect your investments from the surging cost of living while at the same time giving a steady and reliable return guaranteed by the government. Nevertheless, they are not recommended for all types of investors. An example of the type of investor that would be best for TIPS is a long-term one who can stand the losses in a market full of swings and who decides to put a low-risk asset in his/her portfolio.
To sum up, Treasury Inflation Protected Securities (TIPS) are not just inflation hedges, they have their own challenges. Investors are required to look into their financial goals, time horizon, and tax-savvy in making a decision on incorporating TIPS into their portfolios. Knowing the functionality of TIPS and examining the fit of them into your overall investment strategy will make it possible for you to make knowledgeable decisions in terms of protecting your portfolio in the current inflation situation.
You can read more about TIPS on the official website of Treasury Inflation Protected Securities.
