TIPS (Treasury Inflation-Protected Securities)

Inflation-protected investments can help your fixed-income portfolio keep up with inflation.

Treasury Inflation Protected Securities, or TIPS, are one of the best-known inflation fighters. TIPS have been around since 1997. The Treasury uses the Consumer Price Index as a guide to adjust the principal for inflation on a semiannual basis. A fixed interest rate is paid semiannually on the adjusted principal. In that way, both interest payments and the principal are adjusted for inflation. At maturity, if deflation has decreased the value of the security, you're guaranteed to still receive the original principal.

Newly issued TIPS can be purchased without any fee in the months that they are auctioned directly from the government through its TreasuryDirect program. Purchases throughout the rest of the year can be made on the secondary market through investment professionals, banks and brokers. Those purchases will involve a fee or commission.

TIPS

• TIPS are sold with five-, 10- and 20-year maturities and can be purchased for a minimum of $1,000 and multiples thereof. • Five-year TIPS are auctioned in April and October, 10-year are auctioned in January, April, July and October. The 20-year TIPS is auctioned in January and July. • To buy at auction you must place a bid. You can do that through the government's TreasuryDirect Web site or through a broker. • Because of the inflation protection, TIPS typically offer a lower rate of interest than other 10-year Treasury securities that don't have the feature. TIPS are subject to federal income tax, but not state or local taxes. • Keep in mind that in addition to paying tax annually on the interest you receive, you'll also have to pay tax each year on any increases to the principal, even though you won't receive the inflation-adjusted principal until the bond matures. For this reason, it's best to hold TIPS in a tax-deferred account or a Roth IRA.

At a glance
Many experts advise individual investors to purchase TIPS through mutual funds rather than buying individual securities because you'll benefit from the wide array of TIPS held in the fund. Buying individual TIPS can be very expensive because the minimum purchase price is $1,000.

There's an important difference to remember when considering buying individual TIPS vs. buying a TIPS bond fund. You're always certain of getting your full principal if you hold an individual bond until maturity. Sell before maturity and you'll get the current price and risk losing principal.

On the other hand, there is no maturity date when you buy shares in a bond fund. While the individual bonds that make up the fund have maturity dates, the fund itself does not. You should plan to hold your shares for the long haul and sell them when it's most advantageous to you.