Treasury Inflation-Protected Securities (TIPS) are a type of bond issued by the U.S. Treasury Department to protect investors from potential price increases over the long term.
They are debt secured by the U.S. Treasury and carry a predetermined interest rate.
Because the principal amount is constantly changing with changes in the Consumer Price Index, the number of interest payments accrued by TIPS is affected by the volatility spread (CPI).
The risks of investing in individual TIPS are solid investments due to low inflation and relative market risks.
However, Treasury Inflation-Protected Securities (TIPS) are not guaranteed investments, and like other types of bonds, they fluctuate in value.
It is in an investor's best interest to understand the key benefits and dangers involved.
People who hold TIPS bonds to maturity are not affected by the price fluctuations between the date of issue and the date of maturity, although the bond price can change between these two dates.
However, this modest volatility could become problematic if an individual sells the bond before its maturity date. Since the bond's market price may be higher or lower than the face value at the time of sale, there is no guarantee that you will receive the face value of the bond. It is also possible that the official CPI needs to closely track actual inflation or rising costs of goods or services investors demand. This is another potential risk associated with TIPS.
In this case, the inflation protection built into bonds may not protect investors' real purchasing power. The third danger is that deflation is less likely to cause prices to fall.
Investors might sell their TIPS holdings in this case, driving down the price since no inflation protection is needed.
This happened at the height of the 2008 financial crisis when fears of a global economic catastrophe increased the likelihood of deflation and led to a sharp drop in TIPS values in the autumn of the same year.
This happened against the backdrop of this year's financial crisis. Deflation is less likely, but must still be considered. Risks of Investing in TIPS Through Mutual Funds and ETFs When investors buy individual bonds and hold them to maturity, Treasury Inflation-Protected Securities (TIPS) work as expected.
However, investors who hold TIPS through ETFs or mutual funds face other risks. Since the capital value of the bonds the fund has increases with inflation, mutual funds can be considered a form of inflation protection.
On the other hand, unlike individual stocks, bond funds have no maturity date. This suggests that there is no guarantee that investors will receive a return equal to their initial investment.
Because TIPS is very sensitive to changes in interest rates, the value of a mutual fund or exchange-traded fund invested in TIPS may fluctuate significantly within a relatively short period. November 2010 and December 2010 illustrate this risk well.
The U.S. 10-year Treasury yield rose from 2.66% on Nov. 1 to 3.30% on Dec. 31 in two months as bond prices plummeted and interest rates soared. The reason is that bond prices have fallen.
The largest exchange-traded TIPS fund, the iShares Barclays TIPS Bond Fund (ticker: TIP ), returned -3.8% over the same period.
During the same period in 2013, the fund suffered another devastating loss of 8.1% amid a similar surge in U.S. Treasury yields. Understanding the Factors That Affect TIPS Investors should understand the factors that affect the product and price of fixed-income securities to understand TIPS more clearly.
By better understanding what drives TIPS, investors can better understand the opportunities and threats of owning these assets.
Interest rate changes and inflation expectations are key factors affecting tipping.