Today’s Best Inflation Buster: Treasury Inflation-Protected Securities (TIPS) (2024)

Much as I loveI Bonds,the government’s inflation-adjusted savings bonds, Treasury Inflation-Protected Securities (TIPS), may be a better option today. They are providing an even better yield over inflation than I Bonds.

I have written about howI Bonds can help you whip inflationand described the basics of investing in them. My family has bought the maximum $10,000 of electronic bonds a year per person from Treasury Direct over the past two years. I Bonds purchased between May 1 and the end of October yielded an annualized rate of 9.62 percent for six months. That consisted of a fixed rate of zero plus the 9.62 percent annualized inflation adjustment.

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The U.S. Treasury recently announced the new rate for I Bonds purchased over the six months beginning Nov. 1: 6.89 percent, consisting of a 0.4 percent fixed rate, plus an inflation kicker of 6.49 percent. This is still quite attractive, given that the average bank savings account yields 0.19 percent, according toBankrate.com. But TIPS will give you an even better rate than I Bonds, and if you’re worried about inflation, TIPS can help.

TIPS Basics

TIPs are a type of bondissued by the U.S. government. Most bonds make regular interest payments until they mature, at which point investors get their principal back. TIPS also make regular interest payments: The five-year TIPS pays a guaranteed 1.625 percent, plus its principal increases by the inflation rate.

That may not sound like much, but TIPS adjust their principal amount monthly to maintain their real, inflation-adjusted value. For example, if you had a $1,000 TIPS and the consumer price index (CPI) rose 3 percent, your TIPS bond would now have a principal value of $1,030. In the following year, your interest would be calculated on $1,030 rather than $1,000. You’ll never get less than the original principal when the TIPS bond was issued, provided you hold your TIPS to maturity.

While the I Bond bought today gives you a 0.4 percent rate above inflation, that five-year TIPS mentioned earlier yields inflation plus 1.625 percent. That’s 1.23 percentage points in yield more than an I Bond.

There are several differences between TIPS and I Bonds, and Treasury Direct has a chart comparing the two. Unlike I Bonds, TIPS can be bought and sold on the open market. They can also be purchased through any brokerage platform, such as Fidelity, Schwab or Vanguard, but, like I Bonds, they can also be purchased from Treasury Direct. Unlike I Bonds, TIPS can be purchased in retirement accounts like IRAs. For all practical purposes, there are no limits to how much money you can put in TIPS beyond the $10,000 limit a person can buy each year in electronic I Bonds.

Both I Bonds and TIPS are adjusted for inflation using the CPI, although TIPS are adjusted monthly while I Bonds are adjusted semiannually. Unlike I Bonds, you can see the current value of your TIPS whenever the market is open, though I strongly suggest you not look. You already know what your real, inflation-adjusted return will be if you hold to maturity.

David Enna, founder ofTipswatch.com, points out some disadvantages to TIPS relative to I Bonds. The largest is taxes. Interest from I Bonds is tax-deferred until you cash them in. With TIPS, you pay taxes on the interest annually, and to make matters worse, the IRS also taxes you on the inflation component — even though you didn’t actually receive the cash. Holding TIPS in an IRA solves this problem. Enna notes that I Bonds can be used tax-free to pay for educational expenses in some circ*mstances, whereas TIPS cannot.

Which are better today? Harry Sit, founder of TheFinanceBuff.com, told me that now “TIPS are a better value for the long term at the current real yield of about 1.6 percent.” Enna says, “At this point, I’d prefer a five-year TIPS over an I Bond to be held for five years.”

For me, I also think TIPS are generally superior to I Bonds right now, since they provide a greater yield. But that could change at some point. If, like at the beginning of the year, I Bonds begin yielding more than TIPS, I’d prefer I Bonds again. But for now, TIPS provide a greater return.