So you decided this is the time to buy some TIPS on the secondary market. But which one should you buy?

At the time of this writing, there are total of 30 TIPS bonds on the market, with maturities ranging from 2010 to 2032. Much like when you buy a flat screen TV you have to decide roughly what size you want: 50" etc, when you buy TIPS, you have to decide what maturity range you want.

A short-term TIPS (< 5 years) is less risky. It lets you deploy the money elsewhere if your plan changes, but it protects you against inflation only for a shorter period of time.

A long-term TIPS (> 10 years) is more risky. You are locked in for a long time (we are only talking about buying and holding to maturity here, not trading bonds). But a long-term TIPS usually, but not always, has a higher yield. It also gives you inflation protection for a longer period of time.

An intermediate-term TIPS (5-10 years) is just somewhere in between short-term and long-term.

No hard and fast rules here. You pick the maturity range that suits you.

Of course price and yield matter as well. That's where the yield curve comes in. A yield curve is a chart with the bonds' maturity plotted on the X axis and their yield to maturity plotted on the Y axis.

Fidelity produces a nice yield curve when you look up quotes on its web site.

Each blue dot represents a TIPS bond. This chart shows the yield curve is "normal," which means the short-term bonds have much lower yields than the longer-term bonds do, whereas when the yield curve is "inverted," it's downward sloped.

By looking at the yield curve and the quote table, I see the long-term TIPS with 15 years or longer in maturity are yielding 1.8% – 2.1% whereas the shorter term 3- to 8-year TIPS are yielding 0.2% – 1.1%. I don't buy TIPS with less than 3 years in maturity on the secondary market because having inflation protection for only one or two years isn't very meaningful to me.

Suppose you decide to buy a TIPS bond in the range of 3 to 8 years, you still have some tough choices to make. For example should you choose a bond maturing in about 5 years yielding 0.9% or a bond maturing in 7 years yielding 1.2%?

You can calculate the so-called forward rate, which is the rate you must earn in the remaining 2 years after the 5-year bond matures in order to match the 7-year bond. It's done as follows:

((1 + 1.2%) ^ 7 / (1 + 0.9%) ^ 5) ^ (1 / (7 – 5)) – 1 = 1.95%

The calculation means a 2-year TIPS must yield 1.95% or more five years from now if you buy the 5-year TIPS. I think that's a tall order. So if I were to choose between these two bonds, I would choose the 7-year bond. Here's a spreadsheet that makes the forward rate calculation easier:

Spreadsheet: Bond Forward Rate

If deflation is a concern, you can also use the spreadsheet on my blog TIPS During Deflation to see how the bonds behave under different inflation/deflation scenarios. I'm not too concerned about deflation more than five years out.

Finally, don't over-analyze it. The bond market is efficient. Prices and yields are formed by institutions trading millions of dollars a pop. Whatever calculation we can do with our primitive spreadsheets can be done a thousand times faster by bond traders with their sophisticated computer programs. So if you decided to buy a bond on the secondary market, pick one you are comfortable with and go for it.