10-Year TIPS Vs. 10-Year Treasury Bonds
The 10-year Treasury note is the benchmark bond for long term interest rates. It is the longest maturity Treasury security before the jump out to the 30-year bond. TIPS are Treasury securities that provide investors protection against future inflation. TIPS are also issued in a 10-year maturity form along with the 5-year and 30-year TIPS.
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10-Year Treasury Note
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The 10-year Treasury note is issued with a fixed rate of interest payment. Investors owning Treasury notes receive the declared interest amount, called the coupon rate, in two semi-annual payments. The face amount of a Treasury note is paid to the investor when the note matures. The 10-year note is a marketable security, and the current market price is based on the prevailing interest rates. Treasury notes can be purchased through the Treasury auction or through a broker in the secondary bond market.
10-Year TIPS
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The 10-year Treasury Inflation Protected Security is a bond issued by the Treasury that will have its face value increased with the rate of inflation. TIPS are issued with a fixed coupon interest rate and that rate is applied to the bond value as it increases due to inflation adjustments. For example, a $10,000, 3 percent, 10-year TIPS issued in July 2002, was worth approximately $12,170 in February 2011. The 3 percent interest is calculated on this value, providing a semi-annual interest payment of $182, compared to the original $150 every 6 months. TIPS can also be purchased through the Treasury auction or in the secondary market.
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Current Yields
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The trade-off for the inflation protection of the 10-year TIPS when compared to the 10-year Treasury note is a lower initial interest rate. For example, at the January 2011 Treasury auction, the 10-year Note was sold with a yield of 3.38 percent and the 10-year TIPS was auctioned with a yield to investors of 1.17 percent. An investor must decide whether the TIPS bond will grow enough with the inflation factor to make up for the 2.2 percent yield advantage of the 10-year Treasury note.
Decision Factors
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An investor choosing between the 10-year note and the 10-year TIPS should base the choice on inflation and interest rate expectations. If interest rates are expected to decline, the 10-year note locks in the current rates for 10 years. In a rising rate environment, inflation is probably also a factor and the TIPS value will keep up with inflation and outperform the 10-year note. An alternate strategy is to split an investment between the two bond types and get some rate and some inflation protection.
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