TIPS and STRIPS
The U.S. Department of the Treasury offers 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 U.S. Department of the Treasury agrees to pay the initial face value of the bond or the inflation-adjusted face value, whichever is greater.
|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.|
|Risk Profile||No call risk and virtually no liquidity, event or credit and default risk.
Interest rate risk: If interest rates rise, the value of your bond on the secondary market will likely fall.
Inflation risk: No inflation risk, because principal is adjusted semiannually for inflation based on CPI-U.
Opportunity risk: In periods of no or low inflation, other investments, including other Treasury bonds, may perform better.
|Website for More Info||TreasuryDirect's TIPS Web page|
The Separate Trading of Registered Interest and Principal of Securities, or 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.
|Issuer||Financial institutions, government securities broker-dealers|
|Interest Payment||Non-interest bearing: Pays out at maturity|
|How to Buy/Sell||At original issue and on the secondary market through a broker. U.S. Treasury does not sell STRIPS to investors.|
|Bond Interest Rate||Determined at origination and varies by bond. Ask your broker for the rate of individual STRIPS.|
|Price Information||Broker: Quotes are disseminated and traded over-the-counter. No automated quotation service available.|
|Risk Profile||No call risk and virtually no liquidity risk, event risk or credit and default risk.
Interest rate risk: If interest rates rise, the value of your STRIP on the secondary market will likely fall.
Inflation risk: STRIP yields may not keep up with inflation.
|Website for More Info||TreasuryDirect's STRIPS Web page|