# Treasury Inflation Protected Security

(Redirected from TIPS)

Treasury Inflation-Protected Securities (TIPS) are a type of notes and bonds issued by the U.S. Treasury. TIPS are unique because their principal and interest payments are indexed to the rate of inflation as measured by the Consumer Price Index.

TIPS explicitly protect you from inflation. Other "nominal" bonds do not.[1]

## How it works

After a TIPS bond is issued, its principal is adjusted daily using the Non-Seasonally Adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U). If there is inflation, the adjusted principal goes up. If there is deflation, the adjusted principal goes down.

When the bond matures, the U.S. Treasury pays the original or the adjusted principal, whichever is greater. The principal adjustment factor is called the Index Ratio. The adjusted principal is the original principal multiplied by the Index Ratio.

After the CPI-U number is announced for the previous month, the Treasury Department publishes the daily index ratios for the following month. For example, the CPI-U number for May is announced in June. The inflation during the month of May is prorated in the Index Ratios throughout the month of July and reflected fully in the Index Ratio by the end of July. Therefore the inflation adjustment has a lag of two months.[2]

Like regular bonds, a TIPS bond also pays interest twice a year. The semi-annual interest is calculated by multiplying the adjusted principal by one-half of the interest rate on the bond. For example, if a TIPS bond has a stated interest rate of 2% and the index ratio is 1.035 on the date of the interest payment date, a \$1,000 bond will pay interest of

```\$1,000 * 1.035 * 2% / 2 = \$10.35
```

If the index ratio goes to 1.050 on the next interest payment date six months later, the same bond will pay interest of

```\$1,000 * 1.050 * 2% / 2 = \$10.50
```

If the index ratio goes to 0.985 on the next interest payment date another six months later, the same bond will pay interest of

```\$1,000 * 0.985 * 2% / 2 = \$9.85
```

When there is inflation, both the TIPS principal and the interest payments go up with inflation. When there is deflation, both the TIPS principal and the interest payments go down with deflation. On maturity, if the inflation adjusted principal value is below the original face value, the TIPS pays the original face value.

## Role in a portfolio

TIPS belong to the Bonds category. Their role in a portfolio is similar to that of other bonds. Because unexpected inflation is the biggest enemy of fixed income securities and because TIPS offer unique inflation protection, consider including TIPS in your investment portfolio.

A TIPS should work as a good diversifier of equity risk, because it (and the inflation) tends to have slightly negative correlation with equities.[3]

The Treasury Department sells TIPS a few times a year through auctions. After the auction, TIPS trade on the secondary market. You can buy TIPS at the time of the auction or you can buy on the secondary market at any time. You can also buy TIPS through a mutual fund or ETF.

### At auction

If you want to buy TIPS directly from the Treasury, you need to do so during one of their auctions. As of 2019, this is the expected auction schedule (where months marked with an asterisk indicate re-openings of the prior issue):

• 5-year TIPS - April, June*, October, December*
• 10-year TIPS - January, March*, May*, July, September*, November*
• 30-year TIPS - February, August*

The Tentative Treasury Auction Schedule publishes specific auction dates. A few days before the auction date, the Treasury Department also publishes a formal announcement. The announcement includes details of the security being offered. If it is a new issue, the auction sets both the price and the coupon interest rate. The coupon rate is set to nearest 0.125% below the high yield from the auction. If it is a re-opening, the coupon interest rate is already known. The auction will set the yield which in turn determines the price. This online spreadsheet can help you estimate the dollars needed for buying one bond at auction.

After the announcement date but before the auction cutoff time, retail investors can place auction orders through TreasuryDirect or through a brokerage account. TreasuryDirect charges no fee but it only handles taxable accounts. If you want to buy in an IRA, you must use a brokerage account, which can also handle taxable accounts. As of September 2023, Fidelity, Schwab, and Vanguard Brokerage Services charge no fee for TIPS auction orders placed online.

After the auction, the Treasury Department makes another announcement for the auction result. The settlement date is at least one day after the auction date. You must have enough cash available on the settlement date to pay for the bonds.[4]

### On the secondary market

You can also buy TIPS at any time on the secondary market through a brokerage account. The prices from the brokers include a markup over what institutions pay for larger trades. Some brokers also charge a separate commission on top of the markup. TreasuryDirect does not handle secondary market purchases; you have to transfer your bonds to a brokerage and sell them there.

The following link shows some current TIPS pricing and real yields available in the secondary market.

### Through a mutual fund or ETF

Buying TIPS through a mutual fund or ETF gives you a diversified portfolio of TIPS of different maturities. Buying through a mutual fund or ETF also makes it easier for tax reporting and reinvesting interest payments. Because a mutual fund or ETF distributes both the interest income and inflation adjustment of an inflation-indexed bond as income distributions, there are some things you need to be aware of:

1. If you want full inflation protection, you need to reinvest inflation adjustment distributions back into the fund.
2. The inflation/deflation principal adjustment causes fund dividend distributions to vary considerably.[note 1]

For more information on buying individual bonds or a bond fund, see Individual bonds vs a bond fund.

Popular TIPS mutual fund and ETF choices include:

Fund Ticker Type Index Expense Ratio
FlexShares iBoxx 3-Year Target Duration TIPS Index Fund TDTT Short-term ETF iBoxx 3-Year Target Duration TIPS Index 0.18%
iShares 0-5 Year TIPS Bond ETF STIP Short-term ETF Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Years Index (Series-L) 0.05%
PIMCO 1-5 Year U.S. TIPS Index ETF STPZ Short-term ETF BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index 0.20%
Vanguard Short-Term Inflation-Protected Securities Index Fund Admiral Shares VTAPX Short-term mutual fund Barclays U.S. Treasury Inflation-Protected Securities 0–5 Year Index 0.06%
Vanguard Short-Term Inflation-Protected Securities ETF VTIP Short-term ETF Barclays U.S. Treasury Inflation-Protected Securities 0–5 Year Index 0.05%
iShares TIPS Bond ETF TIP Intermediate-term ETF Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) 0.19%
PIMCO Broad U.S. TIPS Index ETF TIPZ Intermediate-term ETF BofA Merrill Lynch US Inflation-Linked Treasury Index 0.20%
Vanguard Inflation-Protected Securities Fund Investor Shares VIPSX Intermediate active mutual fund[note 2] Barclays US Treasury Inflation Protected Bond Index 0.20%
PIMCO 15+ Year U.S. TIPS Index ETF LTPZ Long-term ETF BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index 0.20%
Schwab Treasury Inflation Protected Securities Fund SWRSX Index mutual fund Barclays US Treasury Inflation-Linked Bond Index (Series-L) 0.05%
Schwab U.S. TIPS ETF SCHP Index ETF Barclays US Treasury Inflation-Linked Bond Index (Series-L) 0.05%
SPDR Bloomberg Barclays 1-10 Year TIPS ETF TIPX Intermediate-term ETF Bloomberg Barclays 1-10 Year U.S Government Inflation-Linked Bond Index 0.15%
SPDR Portfolio TIPS ETF SPIP Index ETF Bloomberg Barclays U.S. Government Inflation-Linked Bond Index 0.12%
Fidelity Inflation-Protected Bond Index Fund FIPDX Index mutual fund Barclays US Treasury Inflation-Linked Bond Index (Series-L) 0.05%

## Tax considerations

TIPS are not as tax-efficient as their low reported yields indicate. Both the inflation adjustment to principal and the interest payments are taxable as ordinary income for federal income tax. They are tax exempt for state and local income tax. Thus TIPS are as tax-efficient as nominal Treasury bonds with the same combined yield; if inflation is low and the TIPS yields are low, the tax cost will also be low.

If you must hold inflation indexed bonds in a taxable account, you may also consider I savings bonds; the tax deferral is likely to be worth more than the yield difference. However, if you have maxed out on I Savings Bonds, and need to hold bonds in a taxable account, TIPS tend to have low yields because they have low risk, so they may be reasonable taxable holdings.

If you hold individual TIPS in a taxable account, both the inflation adjustment to principal and the interest payments are taxable as ordinary income for federal income tax, although the bonds do not pay out the inflation adjustment to principal until the maturity date. This problem of paying taxes on income not received until a future date is often referred to as the "phantom income" problem. You must figure out how to report taxable income on your own using the 1099 forms you receive from TreasuryDirect or your brokerage firm.

If you hold TIPS through a mutual fund or ETF in a taxable account, the mutual fund or ETF will figure out and distribute the taxable income to you as dividends. Tax reporting is similar to other Treasury bond funds.[5]

## Current and historical yield and pricing data

• U.S. Treasury, Daily Treasury Real Yield Curve Rates - Real Constant Maturity Treasury rates for 5-, 7-, 10-, 20-, and 30-year TIPS; updated daily.
• Vanguard, Bond Yields - Current yield data for nominal Treasury, TIPS, agency, muni, and corporate bonds. Updated at least daily.
• Wall Street Journal, Inflation-Protected Securities - Yields and price updated daily. Includes adjusted principal values.
• Federal Reserve Bank of St. Louis, graph and data for 5-year, 10-year, and 20-year TIPS constant maturity yield; updated daily with a 1-day delay.

## Historical returns

Figure 1. Composition of US TIPs Returns, Barclays US TIPs Index 2001-2010. Source: Investment Insights: Inflation-Linked Bonds For Long-Term Diversification, TIAA-CREF.

The table below provides annual returns for US Treasury Inflation Protected Securities as measured by Barclays Capital US Treasury Inflation Protected Index and, for short term TIPS, the Barclays US 0-5 Year TIPS Index and the BofA Merrill Lynch 1-5 Year U.S. Inflation-Linked Treasury Index. Figure 1 shows the breakdown of annual return components- real yields, inflation adjustments to principal, and price changes- for the Barclays US Treasury Inflation Protected Index.

Table 1. Index returns for Treasury Inflation Protected bonds[note 3]
Year Bloomberg Barclays US Treasury Inflation Protected Index Bloomberg Barclays US 0-5 Year TIPS Index BofA Merrill Lynch 1-5 Year U.S. Inflation-Linked Treasury Index All Urban Consumers - (CPI-U)
2019 8.43% 4.85% 5.07% 2.3%
2018 -1.26% 0.59% 0.40% 1.9%
2017 3.01% 0.88% 0.82% 2.0%
2016 4.68% 2.81% 3.16% 1.3%
2015 -1.44% -0.02% -0.15% 0.1%
2014 3.64% -1.13% -1.06% 1.6%
2013 -8.65% -1.59% -2.02% 1.5%
2012 6.98% 2.40% 2.67% 2.1%
2011 13.56% 4.51% 5.00% 3.2%
2010 6.31% 3.30% 3.76% 1.6%
2009 11.41% 10.65% 10.59% -0.4%
2008 -2.35% -2.03% -1.77% 3.8%
2007 11.63% 9.80% 10.24% 2.8%
2006 0.41% 2.63% 2.54% 3.2%
2005 2.84% 1.62% 1.64% 3.4%
2004 8.46% 4.96% 4.90% 2.7%
2003 2.60% 5.80% 5.70% 2.3%
2002 16.57% - - 1.6%
2001 7.89% - - 2.8%

## Why is the yield negative?

TIPS may sometimes report a negative yield to maturity.

A bond's yield to maturity can be thought of as the interest rate a savings account would have to pay in order for you to end up with the same amount of money at the time the bond matures.[6]

For example, you buy a nominal bond for \$1,000 with a 2% coupon paid annually that matures in one year. At that time you'll receive \$20 in interest plus \$1,000 in principal for a total of \$1,020. This is the same as you'd get from a savings account paying 2% compounded annually.

But say that because of market conditions, you'd have to pay \$1,005 for the same bond. After one year, you will still receive \$1,020. What is the equivalent savings account interest rate? It would be:

1.49% = (\$1,020 / \$1,005) - 1

Now assume market conditions are such that the price of the bond is \$1,025. What savings account interest rate would make \$1,025 "grow" to \$1,020 in one year? It would have to be a negative interest rate. In this case:

-0.49% = (\$1,020 / \$1,025) - 1

Savings accounts and nominal bonds rarely pay a negative interest rate.

But, TIPS are more likely to have a negative real yield to maturity because investors know they will get an additional return to compensate for inflation.

Assume the bond costing \$1,025 is a TIPS, and that the CPI increases 3% during the year. Investors will get \$1,051 = (\$1,020 X 1.03) a year from now, so they will have a positive nominal return.[6]

## Notes

1. You can see an example of this in the early 2009 distributions from the Vanguard Inflation-Protected Securities Fund. The semiannual report contains the following explanation:

Why the fund skipped a dividend

The income distributions from Vanguard Inflation-Protected Securities Fund are based on the sum of two factors. One is the real yield at which the fund securities were purchased (the "real purchased yield"). The other is the inflation adjustment to the value of these holdings, which is based on monthly changes in the Consumer Price Index. A rise in the index (inflation) increases the principal value of those holdings. Together with the "real purchased yield," this upward adjustment is distributed as income, as required by the Internal Revenue Service. A decline (deflation) reduces the principal value, partially or fully offsetting the real yield. ... [L]ate 2008 was a period of significantly falling prices, or deflation. The inflation-related adjustments to the value of inflation-indexed securities are made with a two-month lag, so the significant deflation experienced in late 2008 offset all of (a bit more than, in fact) the fund’s "real purchased yield" accrued in the first half of 2009. The inflation rate has since crept into positive territory.

— Vanguard Inflation-Protected Securities Fund 2009 Semiannual Report, p.5.

For a complete historical breakdown of the fund's distributions see Important information about Vanguard Inflation-Protected Securities Fund Investor Shares distributions

2. On August 4, 2010, Vanguard filed with the SEC requesting exemptive relief for an offering of an ETF share class of the Vanguard Inflation-Protected Securities Fund. EXEMPTIVE APPLICATION.
3. Source: Returns for the Barclays US Treasury Inflation Protected Index, Barclays Capital Index Products pdf files and ishares ETF returns. Returns before 2011 for the Barclays US 0-5 Year TIPS Index courtesy of Grok, passing along data from Barclays live, available for subscription. Returns for the BofA Merrill Lynch 1-5 Year U.S. Inflation-Linked Treasury Index Eaton Vance Short Term Real Return Fund. CPI-U data US Labor Department Bureau of Labor Statistics.

## References

1. "TIPS In Depth". Treasury Direct.
2. "TIPS Rates & Terms". Treasury Direct.
3. "Inflation-Linked Bonds: Powerful Portfolio Diversifier" (PDF). TIAA-CREF.
4. "Auctions In Depth". Treasury Direct.
5. "TIPS: Tax Considerations". Treasury Direct.