Understanding TIPS
Treasury Inflation Protected Securities (TIPS) is a low risk investment which is backed by the U.S government and aims to protect investors from incurring loss due to inflation. The investments are secured by indexing them directly with inflation; this means that their par value will keep on increasing as inflation increases in the economy but their interest rate will remain fixed. This increase and decrease in inflation can be measured through the Consumer Price Index, and when a TIPS matures, the investor is paid the original or adjusted investment amount— whichever is greater in value.
Treasury Inflation Protected Securities have been exclusively designed in order to evade the risk of bond devaluation due to inflation. They are very popular because, apart from securing the investor against inflation, they also entail an exemption from income tax. TIPS can be purchased by investors through a broker, a bank or directly through a TIPS mutual fund. Purchasing TIPS directly from a mutual fund allows individuals to avoid paying the management fees. An investor can hold on to a TIPS for as long as they require, and they can easily sell it just before it matures, in order to benefit from their investment.
Who can benefit from TIPS
People who want to make a secure investment can benefit greatly by purchasing Treasury Inflation Protected Securities. Gradually, over the past few years, TIPS has gained immense popularity among investors as they ensure to safeguard against any economic unrest, whether it is in the form of demand pull or cost push, inflation. They also protect against any unnecessary fluctuation in the interest rates that may occur due to a change in the government’s fiscal policy. Thus, TIPS is a low-risk investment that, in a way, guarantees profits for the investor.
However, investors should treat Treasury Inflation Protected Securities just like regular bonds, and hold on to them or auction them for a much greater value than their initial price. TIPS ensure that an investor is subjected to an agreement where they will have to return the principal amount after the TIPS has matured, along with an interest which has been charged at a fixed rate.
Further Reading
- Pricing treasury inflation protected securities and related derivatives using an HJM model – www.jstor.org [PDF]
- Nominal rates, real rates, and expected inflation: results from a study of US Treasury Inflation-Protected Securities – www.sciencedirect.com [PDF]
- Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices – papers.ssrn.com [PDF]
- Diversification Benefits of Treasury inflation protected securities: an empirical puzzle – papers.ssrn.com [PDF]
- Inflation or disinflation? Evidence from maturing US Treasury inflation-protected securities – www.tandfonline.com [PDF]
- Treasury inflation protected securities: New Perspectives on their significance to portfolios – search.proquest.com [PDF]
- On the Performance Drivers of US Treasury Inflation-Protected Securities. – search.ebscohost.com [PDF]
- The US Treasury's Inflation-Protected Securities (TIPS): market reactions and policy effects – www.jstor.org [PDF]
- Asset allocation with inflation-protected bonds – www.tandfonline.com [PDF]
