I'd like to explore investing in TIPs but don't know enough to jump in.
Does anyone have a book on TIPs to recommend? Or a website in addition to the Tips Watch?
There have been a lot of very good threads on bogleheads about this lately, look for anything with Kevin M or #Cruncher for details, but be ready to do your homework, there's some things to understand.
The feedback in this thread so far, IMHO, has in many cases been incorrect.
An example is the statement:
"If you buy newly issued TIPs and hold to maturity you are guaranteed to receive nominal value"
EDIT & CORRECTION
The above statement is correct. The first time I read it the "newly issued" part didn't register to me. That's what I get for posting before my second cup of coffee!
Below is what I wrote, which is just saying the same thing:
This isn't true. If you hold to maturity you are guaranteed the "real" value of your investment before taxes. This may seem like a small point, but it's the whole point of investing in TIPs.
Thanks RetMD21 for keeping me honest!
In one of the boglehead threads someone said,
"Investing in TIPS will not make you wealthy, but it's a great way to stay wealthy"
I think this is a good way to look at them. Their purpose is to attempt to preserve purchasing power based on a government yardstick (cpi-u I believe). Yes, there are arguments about how well this measures inflation, as well as whether or not it measures your personal inflation correctly, so one should understand these points before investing.
As has been mentioned, the way they work their inflation adjusted principle value can be reduced by deflation, but cannot go below par value. Again, this will preserve your purchasing power, but not necessarily your nominal value. Also has been mentioned, extended deflation is thought to be unlikely.
TIPS behave best when their is high "unexpected" inflation, otherwise they are priced based on future inflation expectations. One way to look at them is the break-even rate. If you are interested in a 10 year maturity TIPS, take the current nominal 10 year treasury yield and subtract the 10 year TIPS real yield. The result is future average inflation expectations. Current rates are about:
10 year nominal: 2.98%
10 year TIPS: 0.60%
Therefore breakeven is 2.38%
source:
https://www.bloomberg.com/markets/rates-bonds/government-bonds/us
If inflation runs higher than this over 10 years, TIPS are the better bet. If inflation is lower, nominals would be better. If it runs exactly at this rate, they are both equal.
I-bonds versus TIPS have several different points to consider. A few are:
1) Ibonds have low purchase limits (yes they can be increased to a point)
2) Ibonds (currently) offer a zero real return over inflation before taxes, while TIPS offer a real return over inflation before taxes (at least currently for most maturities)
3) Ibonds are tax deferred for federal taxes, while TIPS you pay taxes on the phantom inflation principle increases yearly, so they are best held in tax advantaged accounts
4) I bonds can be redeemed any time after a year with a 3 month interest penalty or no penalty after 5 years, making them very flexible
5) I bonds cannot lose your nominal investment due to deflation
I think a good use of TIPS is to use them to create an inflation adjusted bridge to social security at age 70. One can create a bridge of individual tips maturing each year until one reaches age 70.
I bonds are also excellent for an emergency fund due to their flexibility.
As for how TIPS work, bogleheads, tipswatch, eyebonds, and others have better explanations than I can offer.