What are TIPS?
When most people think of tips they think of great service at a restaurant, or a wise cracking know-it-all, but TIPS as it pertains to the world of finance and the Prosperity Plan are very different. In finance terms, TIPS stands for Treasury Inflation-Protected Security (TIPS). TIPS is a treasury bond that is indexed or tied to an inflationary gauge to protect investors from the decline in purchasing power of their money. The principal value of TIPS rises as inflation rises while the interest payment varies with the adjusted principal value of the bond.
Positives of Tips: TIPS are good because they protect you against inflation. If I have a regular bond that is guaranteed to pay me 3% for the next 5 years as an example and inflation (the costs of goods and services) is increasing at say 8%, I am actually losing 5% a year, meaning the money that I thought looked good locked in at 3% is now not looking so great. With TIPS, if inflation increases to 8%, the facevalue of the TIPS would adjust upwards by 8%. In upwards adjustment is based based on the Consumer Price Index. Also the dividend payment, would also adjust up in line with the inflation number. TIPS are kind of like bonds, but in an inflationary environment behave differently (better) than a bond.
Tips are important in today’s current environment because of the massive amount of new money that is being added to central banks balance sheets. Money printing itself, doesn’t cause inflation, the velocity (spending) of money does. But with so much money being printed, eventually that cash will get spent, and when it does, look out for inflation. Tips protects against this.
Negatives of TIPS: In a deflationary environment, TIPS typically do not perform well (see chart below). In deflation, cash is king. Bonds are a better bet for deflation than TIPS. In inflation, TIPS are a good safe hedge.
Recommending Portfolio Allocation: 10%
How to Purchase TIPS: So you have decided to purchase TIPS, congrats! Now, how to do it? There are a few ETF’s which give quick and easy exposure to TIPS. In no particular order they are:
The iShares TIPS Bond ETF (TIP)
The Schwab US TIPS ETF (SCHP)
The FlexShares iBoxx 3-year Target Duration TIPS Index ETF (TDTT)
TIPS can also be purchased directly as individual bonds through the U.S. treasury or a broker.