Smart Bond Investing—Types of Bonds
For several years now, the U.S. Department of the Treasury has offered bonds that help protect investors against inflation. They're called Treasury Inflation Protected Securities, or TIPS. Issued with maturities of five, 10 and 30 years, TIPS shelter you from inflation risk because their principal is adjusted semiannually for inflation based on changes in the Consumer Price Index-Urban Consumers (CPI-U), a widely used measure of inflation. Interest payments are calculated on the inflated principal. So, if inflation occurs throughout the life of the bond, interest payments will increase. At maturity, if the adjusted principal is greater than the face or par value, you will receive the greater value.
Because they are U.S. Treasury securities, TIPS are backed by the "full faith and credit" of the U.S. government and, therefore, carry virtually no credit or default risk. Remember the trade-off between risk and reward? It holds for TIPS as well. While the TIPS investor is sheltered from inflation risk and, in fact, benefits during periods of inflation, the trade-off is that the base interest rate on TIPS is usually lower than that of other Treasuries with similar maturities. In periods of deflation, low inflation or no inflation, a conventional Treasury bond can be the better-performing investment.
You might ask, "What happens if deflation (a negative inflation rate) occurs? Would my TIP investment be worth less than what I paid for it?" No, unless you paid more than the face value of the bond or sell it before it matures. Upon maturity, the Treasury Department agrees to pay the initial face value of the bond or the inflation-adjusted face value, whichever is greater.
TIPS Risk Report Card
For more information on TIPS, see the TreasuryDirect® Treasury TIPS Web page.
|How to Buy/Sell||At original issue through TreasuryDirect or broker. On the secondary market through a broker.|
|Bond Interest Rate||Tied to Consumer Price Index. Rate information at TreasuryDirect website or through a broker.|
|Price Information||TreasuryDirect for original issues. Broker data vendors for secondary trade data.|
|Website for More Info||TreasuryDirect's TIPS Web page|
STRIPS is the acronym for Separate Trading of Registered Interest and Principal of Securities. The STRIPS program lets investors hold and trade the individual interest and principal components of eligible Treasury notes and bonds as separate securities. STRIPS can only be bought and sold through a financial institution or brokerage firm (not through TreasuryDirect), and held in the commercial book-entry system.
STRIPS Risk Report Card
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