If you are not familiar with inflation indexed bonds Treasury Inflation Protected Securities (TIPS), I suggest you start with a mutual fund or ETF, then progress to participating in a few TIPS auctions before you jump into buying TIPS on the secondary market. That way you will understand better how they work. If you are ready for the secondary market, here we go.

First of all, what does buying TIPS on the secondary market mean? It means you are buying the bonds from other people who already own them. Bond dealers make a market in these bonds. They advertise a price at which they are willing to buy ("bid price") and a slightly higher price at which they are willing to sell ("ask price"). This is very similar to how the stock market works. Like stocks, market prices for bonds also change every minute or every second. But unlike buying stocks, retail investors usually cannot get the current market price when they buy bonds. Only institutions who buy and sell millions of dollars worth of bonds can see the market price. Retail investors can only buy from retail brokers who often add a markup.

When you buy TIPS from auctions, you are buying directly from the issuer, the U.S. Treasury. You pay the same price as the institutions pay. There is no markup in auctions. Then why should we even consider buying on the secondary market? Because most of the time we have no better choice.

The Treasury department only holds TIPS auctions a few times a year. The secondary market is open all year round. Sometimes the prices are attractive but there is no auction. If you want to take advantage of the attractive prices, you have to buy it on the secondary market. When U.S. Treasury holds an auction, it only does it for one bond. The secondary market has all issues trading all the time. If Treasury is doing an auction for a short-term bond but you want a long-term bond, you have two choices: (1) wait or (2) buy it on the secondary market.

Because you are buying on the secondary market from an existing owner, not directly from the U.S. Treasury, you need a brokerage account. You can't do it in TreasuryDirect. Almost any brokerage account will do, although different brokerage firms will have different pricing and commission structures.

TIPS are still bonds, which are not tax efficient. For that reason, they are best bought in a tax deferred or tax free account. Using a tax deferred or tax free account also makes it easier for tax reporting. In a taxable account, there are issues like Bond Premium Amortization (BPA) and Original Issue Discount (OID). Because I have never bought individual TIPS in a taxable account, I don't profess to have a thorough understanding of how to deal with BPA and OID. If you are interested in buying TIPS on the secondary market in a taxable account, please read IRS Publication 1212 Guide to Original Issue Discount (OID) Instruments and IRS Publication 550 Investment Income and Expenses. I avoid dealing with them by using a tax deferred account.