Treasury inflation-protected securities (TIPS) are a very beneficial addition to many investment portfolios because of their diversification benefits and protection when inflation is rising. Treasury inflation-protected securities are adjusted to the most commonly used inflation measure, the Consumer Price Index (CPI). When the CPI rises, the principal amount of TIPS is adjusted upward, and when the CPI falls, the principal is adjusted downward. The coupon rate stays constant, thus generating varying amounts of interest-based off on the inflation-adjusted principal. The end result is that investors are protected against inflation.
This asset class generally does not provide high yields because of its low-risk nature. However, some TIPS bond funds do have attractive yields, including the iShares 0-5 Year TIPS Bond (STIP) and The Vanguard Inflation-Protected Securities Fund (VIPSX).
Treasury Inflation-Protected Securities (TIPS)
iShares 0-5 Year TIPS Bond (STIP)
Performance Over One-Year: 5.48%Expense Ratio: 0.03%Annual Dividend Yield: 4.46%Assets Under Management: $10.24 billionInception Date: Dec. 1, 2010Issuer: BlackRock Financial Management
The iShares 0-5 Year TIPS Bond ETF by BlackRock replaced a previous fund mentioned here due to its higher exposure to short-term U.S. TIPS, lower expense ratio, and higher total return. The fund boasts a 1-year total return of 5.48% which outperforms the benchmark index, the Bloomberg U.S. Treasury Inflation-Protected Securities 0-5 Years Index (Series L).
The expense ratio of the fund is absurdly low, sitting at 0.03%. This is much lower than the fund it replaced, which charged a substantial 0.62%. Over half a percentage point is reason enough to consider STIP over some competitors, even those with much higher net assets. STIP is relatively small at just over $10 billion under management, compared to Vanguard’s offering which manages over $41 billion.
STIP pays a monthly distribution on its yield and trades on the price of its 17 holdings. The impressive 30 day SEC yield of 5.38% is slightly higher than other funds in the category, with its funds carrying an average maturity of 2.61 years.
Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX)
Performance Over One-Year: 6.38%Expense Ratio: 0.20%Annual Dividend Yield: 5.08%Assets Under Management: $41.3 billionInception Date: June 6, 2000Issuer: The Vanguard Group
The Vanguard Inflation-Protected Securities Fund is one of the largest TIPS funds available with $41.3 billion in net assets. The fund invests in bonds backed by the full faith and credit of the federal government and whose principal is adjusted quarterly based on inflation. VIPSX has 50 holdings, and 100% of them are U.S. TIPS. It has an average effective duration of 7.9 years.
The minimum investment for this fund is $3,000. Although the expense ratio is considered by Morningstar to be “below average,” it is hard to view it as such when STIP sits at 0.03%. The Vanguard offering is for those who are looking for a more long-term approach to their high-yield TIPS strategy.
Although the “real return” of some TIPS funds can appear negative, they can still beat inflation (depending on the timeframe).
Investing in a TIPS fund is not the same as investing in actual TIPS. TIPS funds carry baskets of TIPS products in order to deliver returns and produce the desired yield. However, individual investors can purchase individual TIPS bonds if they feel a particular one might be more beneficial than a TIPS fund. However, funds will always limit exposure to individual price movement and are generally considered a safer alternative to individual TIPS offerings.
The downside is that an investor will be paying a slight management fee to the fund that pays for the funds balancing of the TIPS fund. TIPS funds are not able to reach maturity, unlike a TIPS bond, and as such are only able to be cashed out at the current price, which is not always a higher price than your initial investment. For this reason, TIPS funds are considered a riskier investment than a simple TIPS bond.
What Are TIPS Funds?
TIPS funds are funds that invest in and hold a number of TIPS bonds. The securities mentioned in this article have between 17 and 50 bonds that make up the fund the investor might invest in. TIPS funds allow investors access to a wide range of products without locking them into maturity dates like a bond would.
Are TIPS Better Than Regular Bonds?
TIPS cannot relaly be considered better or worse than regular bonds because they are different products. Although they operate in the same area (treasury inflation-protected securities) a fund is designed to offer investors a wide range of options within a single security and with much more liquidity than a bond.
Can You Lose Money on TIPS?
You can absolutely lose money on TIPS, however they are considered a relatively safe investment. The volatility will be higher than some other treasury instruments but TIPS will almost always be more stable than individual stocks.
How Are TIPS ETFs Taxed?
TIPS ETFs are taxed in a more aggressive way than bonds. You are taxed on both the annual income and the amount of the adjusted value.
The Bottom Line
The two TIPS funds listed in this article give investors liquid access to the TIPS market while providing somewhat of a safety net in their composition. The expense ratios are low but investors need to pay attention to taxation on TIPS products, as it can eat away at the slim profit margins associated with TIPS. It is worthwhile to note that although the funds may seem to produce great returns, they need to be compared against inflation in order to ascertain the “real” return.