Over the past few months, TIPS have become an increasingly attractive option for the fixed income portion of your retirement portfolio.
I am referring, of course, to Treasury inflation-protected securities. They are similar to traditional treasury bills and bonds, except that their quoted yields are above and above the consumer price index. Real returns, in other words.
Right now, 10-year TIPS are yielding 1.29%, meaning you’re guaranteed to earn at least as much as inflation over the next decade if you buy them today and trade them. keep until maturity.
The reason TIPS have become more attractive in recent months is that after trading for several years with negative real yields, in May those yields began to rise above zero and are now well above 1%. As you can see from the attached chart, the 10-year TIPS yield is currently the highest in the past decade.
In fact, the positive real yield of TIPS makes them in some ways more attractive than I-Bonds, US savings bonds whose yields are based on the prevailing rate of inflation. I-Bond rates are a combination of the rate of change of the CPI and a fixed rate set at the time of purchase. Although the US Treasury may change this fixed rate in the future, it is currently set to zero, which means that, for now, the actual return on I-Bonds is precisely zero.
Since the fixed I-Bond rate can never be negative, I-Bonds were more attractive than TIPS during periods of the past decade when real TIPS yields were negative. This situation has now been reversed.
Of course, there is no guarantee that TIPS yields will not fall back into negative territory in the future. But if that happens, you would have the option of selling your TIPS on the secondary market before maturity, as they would now be trading above par and, where possible, reinvesting the proceeds in I-Bonds with zero real return.
Sell before expiration
The only major risk when investing in a TIPS is therefore the possibility that you will have to sell it before maturity and that its yield will be higher then than when you bought it. I-Bonds do not have this risk, since their value does not fluctuate; after an initial period during which you cannot sell without penalty, you can sell your I-Bonds at any time at the same fixed (real) rate set at the time of your purchase.
So what is the risk that TIPS have compared to I-Bonds? As the attached chart illustrates, the 10-year TIPS yield is well above the 10-year average. Assuming its return reverts to the mean, you might feel comfortable betting that it is more likely to be lower in the future than higher.
The choice between TIPS and I-Bonds largely comes down to your risk tolerance. As Zvi Bodie, who for 43 years was a professor of finance at Boston University, put it in an email, “You can lose money on TIPS, but not on I-Bonds. With I-Bonds, there is no downside risk… It is extremely valuable.
In contrast, Harry Sit of The Finance Buff thinks ADVICE is best right now. “When the 5-year TIPS yield is 1.27%,” Sit wrote in an email, “it’s hard to justify keeping the I-Bond rate fixed at 0%.”
Either way, Sit added, “Because I-Bonds have an annual value [purchase] limit, you don’t have to choose between I-Bonds and TIPS. Buy both, and you won’t have to wonder which is better.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be reached at [email protected]