Treasury Inflation-Protected Securities (TIPS)
Definition
Treasury Inflation-Protected Securities (TIPS) are a type of U.S. Treasury security specifically designed to protect investors from inflation. The principal value of TIPS is adjusted based on the Consumer Price Index (CPI), which measures inflation. As the CPI rises, the principal of TIPS increases. Conversely, if the CPI falls, the principal decreases.
Examples
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Purchase of TIPS for Retirement Planning: An investor buys $10,000 worth of TIPS with a 10-year maturity to safeguard their retirement funds against inflation. Over time, as the CPI increases, the principal amount is adjusted upward, thus preserving the purchasing power of their investment.
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Using TIPS for Diversification: A portfolio manager includes TIPS in a diversified investment portfolio to balance potential equity market losses and ensure inflation protection. As inflation protection, TIPS potentially offer a hedge during periods of rising inflation.
Frequently Asked Questions (FAQs)
Q1: How do TIPS differ from regular Treasury bonds?
- A1: Unlike regular Treasury bonds, TIPS provide an inflation adjustment mechanism that increases the principal based on changes in the Consumer Price Index (CPI), thus offering protection against inflation.
Q2: Are TIPS a good investment?
- A2: TIPS can be a good investment for those looking to protect their portfolios from inflation. They are considered low-risk investments backed by the U.S. government.
Q3: How often is the principal of TIPS adjusted?
- A3: The principal of TIPS is adjusted semi-annually based on changes in the Consumer Price Index (CPI).
Q4: Can the value of TIPS decrease?
- A4: Yes, if there is deflation (a drop in the CPI), the principal value of TIPS can decrease. However, at maturity, you are guaranteed to get at least the original principal amount.
Q5: How are TIPS taxed?
- A5: Although the inflation adjustments to the principal are not realized gains, they are subject to federal income tax in the year they occur. The interest income paid by TIPS is also federally taxable.
Related Terms
- Consumer Price Index (CPI): A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care, used as an indicator of inflation.
- Treasury Bonds: Long-term fixed-rate debt securities issued by the U.S. Treasury with maturity periods of more than 10 years.
- Inflation: The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.
Online References
- U.S. Treasury - TIPS
- Bloomberg TIPS Information
- Investopedia – Treasury Inflation-Protected Securities (TIPS)
Suggested Books for Further Studies
- “The Bond Book, Third Edition: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Saving for Retirement (Without Living Like a Pauper or Winning the Lottery)” by Gail MarksJarvis
- “The Only Guide to a Winning Bond Strategy You’ll Ever Need: The Way Smart Money Preserves Wealth Today” by Larry E. Swedroe
Fundamentals of Treasury Inflation-Protected Securities (TIPS): Finance Basics Quiz
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