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Why Buy TIPS Print E-mail
Written by TFB   
Last Updated on April 07, 2009

Why buy TIPS? To make money, of course.

TIPS are bonds. Investors buy TIPS for all the reasons they buy bonds: for earning interest income; for lowering risk in their investment portfolio; for speculating on interest rate changes.

TIPS are issued by the United States Treasury. Investors buy TIPS for the same reason they buy Treasury bonds: for their high credit quality. The interest payment and principal repayment are guaranteed by the full faith and credit of the U.S. Treasury.

In addition, investors buy TIPS for inflation protection. Because the principal repayment and the interest payments are indexed to the Consumer Price Index, TIPS offer guaranteed inflation protection. No matter how high the Consumer Price Index (CPI) goes after you buy the TIPS bonds, you know for sure your interest income and your final principal payback will go up at the same pace as the CPI. Regular ("nominal") bonds don't have this guarantee. The interest payments and the principal payback on nominal bonds are fixed. The biggest enemy to nominal bonds is inflation. Over time, inflation eats away the value of the interest and the principal. A CD with a 6% interest rate sounds good if the inflation is 2% a year, but it's not so good if the inflation is 8% a year. With TIPS, you are guaranteed a “real” interest rate after inflation, regardless whether the inflation ends up being 2% or 8%. Therefore buying TIPS is like buying insurance on unexpected inflation. An investor concerned about the impact of higher than expected inflation should considering buying TIPS as a part of their balanced portfolio.


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