How to Buy TIPS
TIPS, or Treasury Inflation-Protected Securities, can be a great hedge against inflation. Backed by the U.S. government, they are less volatile than bonds and safer than stocks. But purchasing them can sometimes be tricky.
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Instructions
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Understand what you're buying
TIPS are government-backed securities that are indexed against the Consumer Price Index (CPI). What this means is that as inflation increases, the value of your investment increases as well. For example, if you initially purchase $1000 in TIPS and prices double over the term, your principal will be worth $2000 at maturity. For more information on determining whether TIPS are right for your portfolio, see the Resource Section.
There are two main ways to buy TIPS. You can purchase them directly through the U.S. Department of Treasury or through a brokerage account. Both methods have pros and cons - read on!
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Purchase TIPS directly from the U.S. Treasury
TIPS can be purchased online, 24/7, from the United States government at www.treasurydirect.gov. First, set up a TreasuryDirect account. For your account, you'll need your Social Security number, a United States address, a checking or savings account, and an e-mail address.
TIPS can be purchased in increments of $100, with a minimum purchase of $100 and a maximum of $5 million. They are issued electronically with maturity terms of either 5, 10, and 20 years. You do not have to hold them to maturity and can sell them at any time. The interest rate you'll receive is determined at the time of purchase - typical rates are around 2%.
When your TIPS matures, you'll receive the inflation-adjusted principal or original principal, whichever is greater. The interest is paid every six months, at the fixed interest rate. However, the rate is applied to the adjusted principal, so, like the principal, interest payments rise with inflation and fall with deflation.
Advantages:
- No transaction fees or other costs
- Direct access to your TIPS online
- You won't lose your principal if the CPI dropsDisadvantages
- Interest is paid only twice a year
- The growth in principal is subject to federal income tax even though you won't actually receive the income until you sell the TIPS or they reach maturity. -
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Purchase TIPS through an ETF
Another option for purchasing TIPS is by buying shares of an exchange-traded fund (ETF). An ETF invests in a variety of different TIPS with varying interest rates, maturity dates, etc.
To purchase shares in an ETF, you'll first need a brokerage account. There are different ETFs to choose from, such as the Vanguard Inflation-Protected Securities fund (ticker symbol VIPSX) and the iShares Barclays TIPS Bond Fund (ticker symbol TIP). These are the two largest TIPS ETFs in the country. You buy and sell shares in these ETFs exactly the same as you would a stock.
Advantages:
- Interest paid out monthly or quarterly (fund dependent)
- Increases in principal (due to increase in the CPI) paid out monthly or quarterly - you don't have to wait until maturity
- Ability to automatically reinvest paymentsDisadvantages
- Commissions charged by brokers to buy and sell ETF shares
- Deflation can possibly cause some loss of principal because the older TIPS in the ETF will have already paid out some part of their inflation increases before you've bought shares.
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Tips & Warnings
Interest income and growth in principal are exempt from state and local income taxes.
Interest income and growth in principal are subject to federal income tax.
