How to invest in Treasury Inflation-Protected Securities

Fixed-income investments run the risk of not keeping up with inflation. Inflation is when the prices for goods and services rise. If this happens, investments with a fixed rate of return will have lower purchasing power upon maturity. However, there is a fixed-income investment product designed to keep up with inflation.

This product is known as Treasury Inflation-Protected Securities, or TIPS. In this video, you’ll learn about TIPS, their benefits and risks, and how they might fit into a fixed-income portfolio. TIPS are issued by the U.S. Treasury and pay interest twice a year at a fixed rate. However, unlike other bonds, the principal of the TIPS is tied to the Consumer Price Index, or C-P-I, which measures inflation.

If the CPI rises, the value of the principal will rise as well. When future interest payments are made, they’ll be adjusted to this higher principal. This means you receive the benefit of regular interest payments and the principal growth needed to keep up with inflation. Another benefit of TIPS is their relative safety. They’re issued by the U.S. Treasury, which means they’re backed by the full faith and credit of the U.S. government. But, like all investments, TIPS have risks. Because TIPS can be adjusted for inflation, they tend to have lower yields than other Treasuries. Also, like other bonds, TIPS have interest rate risk.

This means if interest rates rise, new bonds usually pay a higher rate and the value of your TIPS investment will decline.

So, if you have to sell your TIPS before maturity, you may receive less than your original investment. Additionally, there are a few tax considerations. Most bond interest payments are taxed as normal income each year. Also, any increases in the principal aren’t taxed unless you sell the bond. With TIPS, an adjustment to the principal may be taxed before the bond is sold or redeemed. This means you may be required to pay additional taxes.

However, like other Treasuries, TIPS are only taxable on the Federal level, and not the state. Now that you understand what TIPS are and their risks and benefits, let’s discuss how they’re purchased.

First, TIPS can be acquired directly from the U.S. Treasury at 5-, 10-, and 30-year maturities. TIPS may also be available through your brokerage firm as individual bonds or in different types of funds. While TIPS are one way to diversify a fixed-income portfolio, they shouldn’t be your only fixed-income investment.

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