On sale this week: Treasury Inflation-Protected Securities.
It wasn’t so long ago that the real rate on these bonds was negative. People lent money to the federal government and were assured of getting back, with interest included, less than they started with.
Now the yield on the TIPS due in 2056 is 2.7%, close to as high as it has ever been. That bond will beat the standard-issue unprotected Treasury of 2056, recently paying 5%, if inflation averages at least 2.3% over the next 30 years.
Do you think inflation will average more than 2.3%? It’s a reasonable supposition. The last Consumer Price Index showed up with a 3.8% yearly gain.
There’s a decent chance that stocks will deliver better than a 2.7% real return over the next 30 years. But they are volatile. An all-stock portfolio would mean sleepless nights for a saver no longer in the work force.
Put it all together and you have a good case for having a collection of TIPS as the stable anchor in a balanced retirement portfolio.
Inflation damages bonds paying back in nominal dollars, a category that includes most Treasuries and virtually all corporate and mortgage debt. TIPS are immune from that hazard but they share two other risks with conventional bonds.
The big one is interest-rate risk, explains Collin Martin, a fixed-income seer at the Schwab Center for Financial Research. Buy a TIPS due in some future year and you can be sure of getting a certain return in purchasing power between now and then. But there will be bumps along the way, which will matter if you have to cash in early. When real rates rise, TIPS prices fall. In the market crash of 2022, TIPS suffered alongside conventional Treasuries. When real rates fall, TIPS prices go up.
A more theoretical risk is default. Martin notes that the three big rating agencies—first Standard & Poor’s, in 2011, and since then Fitch and Moody’s—have downgraded the federal government from AAA to AA+ in credit quality. Chronic budget deficits are hard to ignore. Evidently bonds from Microsoft, a rare AAA corporate borrower, are safer than Treasuries.
It’s quite possible, Martin says, that a congressional standoff over the federal debt limit could result in a suspension of Treasury payments, but likely that debt holders would eventually be made whole. It’s unlikely but not impossible that the U.S. will engage in a restructuring of the sort common at deadbeats like Argentina. Says Martin: “We don’t think you’d get stiffed.”
The U.S. Treasury runs a TIPS auction roughly once a month, offering bonds due in 5, 10 or 30 years. If you are patient, you could build a TIPS portfolio of several maturities by participating in several auctions. Some brokers, including Schwab, will handle the auction paperwork for you at no cost.
For a quicker deployment, buy TIPS second-hand. Your stockbroker will offer 50 or so issues, with maturities available in most of the years between 2027 and 2056. You can put together a portfolio of TIPS issues without a lot of mental strain.
At the beginning of June, yields on TIPS ranged from 0.9% for next year’s crop to 2.7% or so for the ones due in 2048 or later. It often makes sense to spread TIPS maturities over a long stretch of years. But in the second-hand market it’s also important to keep trading costs down. That means doing a trade only if you can afford to take on at least $100,000 of face amount, which in traders’ lingo is called 100 bonds.
What to do with smaller stakes: Use a fund. Funds of TIPS can be found with expense ratios as low as 3 basis points, or 0.03%. (For the Best Buys, see the Forbes TIPS Buying Guide.) That means giving up $30 a year to middlemen for every $100,000 invested. Not bad, but not quite as good as the deal you get when you have the patience and the wherewithal to acquire individual bonds. Buying bonds in the secondary market, at least 100 at a time, and holding to maturity will result in middlemen costs of more like $6 a year per $100,000 invested.
Here are the steps you’d take at Schwab to buy an individual inflation-proof bond. (Fidelity Investments may offer something comparable; it declined to be interviewed.) On the Schwab home page select “Research.” Then select “Bonds, CDs and fixed income.” Then, just to the right of the “Overview” tab, select “Find bonds and fixed income.”
On the resulting screen, click the “Both buy and sell” box. Fill in 100 as the number of bonds you want. Change the bond type from “Corporates” to “Treasuries.” Toward the bottom of the page click the “Include only TIPS” box, then “View Search Results.”
Now export the results of your search to a spreadsheet. Rearrange the sheet so that each line has a coupon and maturity followed by a bid yield and an ask yield. You’re going to be earning the ask yield, the lower of the two, since you are buying at the ask price.
Add a column to your spreadsheet that calculates the difference between the two yields. You want that difference to be small. The most actively traded bonds have the smallest spreads, and these are the ones to prefer when you assemble a portfolio.
Schwab charges no commission for TIPS trades done online; the firm and the dealers it works with make all their money from the spread between bid and ask prices. Good news: These days spreads are pretty tight. In yield terms, spreads at Schwab recently averaged 1.2 basis points for the bonds due in 2031 and later.
All this looks trickier than it is. Your work is limited to selecting a quantity, selecting a bond, and hitting the “Buy” button.
A companion article, the Forbes TIPS Buying Guide, gets into the specifics: how to select individual bonds, which funds are the best buys, how the taxes work and why I Bonds are not such a great deal.