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This article is relatively easy to write. The answer is simple. Treasury Inflation-Protected Securities (TIPS) are, currently, poor investments because, like standard Treasury bills, notes, and bonds, they are selling at rather unattractive prices. (For an understanding of how overpriced standard Treasury bills, notes, and bonds are, please see my previous articles entitled "The Best Long-Term Non-Junk Bond Investments", "The Best All/Intermediate-Term Non-Junk Bond Investments", and "The Best Short-Term Non-Junk Bond Investments Are CDs, Not Bond Funds Or Bonds".)

Yes, you may be taking on less risk since the principle value of TIPS adjusts to accommodate for inflation, and, yes, like other Treasuries, TIPS are exempt from state and local income taxes; but, if the price is poor enough, TIPS are just not worth owning. The price is poor enough, and TIPS are just not worth owning. Stated otherwise, there is an important difference between being smart about inflation and being paranoid about it.

Principal value changes for TIPS are based upon the U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U). In the last 20 years or so at least, CPI-U has tended to be higher than the PCE (Personal Consumption Expenditure) price index measure of inflation I used in a previous article(s). This being the case, I downloaded CPI-U data from the Bureau of Labor Statistics and estimated what CPI-U has been since inflation was brought under control in the 1990's. My analysis yielded a number of 2.4725%. As expected, this was higher than the future inflation expectation of 2.22% I previously derived otherwise. If you go back further than the 1990's, average inflation to date is higher than these numbers; but, if you go back even further, average inflation to date is very similar to the 2.4725% and 2.22% numbers. I will use the 2.4725% number in evaluating TIPS.

There are three types of TIPS―30-year, 10-year, and 5-year. I will use the auction results for the most recent new issue for each type of TIPS to evaluate TIPS.

30-Year TIPS

  • Term: 29 years, 3.5 months
  • Issue Date: 10/31/12
  • Auction Date: 10/18/12
  • Yield: 0.479%
  • Future Inflation Expectation: 2.4725%
  • Yield + Future Inflation Expectation (1): 2.9515%
  • Standard (Non-TIPS) 30-Year Treasury Bond Rate at Auction Date Close (2): 3.007%
  • (1) minus (2): -0.0555%

10-Year TIPS

  • Term: 9 years, 9.5 months
  • Issue Date: 9/28/12
  • Auction Date: 9/20/12
  • Yield: -0.750%
  • Future Inflation Expectation: 2.4725%
  • Yield + Future Inflation Expectation (1): 1.7225%
  • Standard 10-Year Treasury Note Rate at Auction Date Close (2): 1.777%
  • (1) minus (2): -0.0545%

5-Year TIPS

  • Term: 4 years, 7.5 months
  • Issue Date: 8/31/12
  • Auction Date: 8/23/12
  • Yield: -1.286
  • Future Inflation Expectation: 2.4725%
  • Yield + Future Inflation Expectation (1): 1.1865%
  • Standard 5-Year Treasury Note Rate at Auction Date Close (2): 0.687%
  • (1) minus (2): 0.4995%

As you can see, when adjusted for the future inflation expectation, 30-year and 10-year TIPS are simply paying about the same as standard 30-year and 10-year Treasuries. The 5-year TIPS seems to be paying a little better than about 0.5% more than a standard 5-year Treasury, but this is deceptive. The 12-month CPI-U inflation rate for July, 2012 was 1.4%. The market was simply anticipating that, for the 4 years, 7.5 months term of the TIPS, CPI-U inflation will be about 2% versus about 2.5%. As of September, the most recent month for which there was a measurement, 12-month CPI-U inflation was 2%; and inflation is expected to be lower than average until the economy gets much stronger.

If you are considering purchasing or own a TIPS fund, versus individual instruments you can hold to maturity, the situation is even less attractive. As is the case with standard Treasuries funds, TIPS fund share prices have increased as interest rates have fallen. When interest rates return to more usual levels, as they very likely will in the intermediate/long-term, these increases in share prices are going to be decreases in share prices. The longer-term the TIPS instruments are, the larger the decreases are going to be.

Below is a Morningstar chart showing the price performance of the eight (U.S.) domestic TIPS ETFs with the longest track records. Starting with the line finishing highest and working down, the blue-grey line is PIMCO 15+ Years U.S. TIPS Index ETF (NYSEARCA:LTPZ), the dark green line is SPDR Barclays Capital TIPS (NYSEARCA:IPE), the dark red line is PIMCO Broad U.S. TIPS Index ETF (NYSEARCA:TIPZ), the dark blue line is iShares Barclays TIPS Bond (NYSEARCA:TIP), the pink line is Schwab U.S. TIPS ETF (NYSEARCA:SCHP), the yellow line is PIMCO 1-5 Years U.S. TIPS Index ETF (NYSEARCA:STPZ), the mustard line is FlexShares iBoxx 5 Year Target Duration TIPS ETF (NYSEARCA:TDTF), and the light blue line is iShares Barclays 0-5 Years TIPS Bond (NYSEARCA:STIP). FlexShares iBoxx 3 Year Target Duration TIPS ETF (NYSEARCA:TDTT) and Vanguard Short-Term Inflation-Protected Securities ETF (NASDAQ:VTIP), which have a shorter history, present a similar story.

click to enlarge image

TIPS ETF Share Prices Chart - 121108

The situation is worse than it appears on the chart for a couple of reasons. For one, six of the eight ETFs on the chart do not have a history that goes back to before the last recession and the financial crisis, when interest rates were more usual; so the chart lines for these six ETFs under-indicate how much share prices will fall when interest rates return to more usual levels. For another, the share price decreases will be greater than the share price increases were due to fund expense ratios.

In brief, currently, TIPS are tipped against you. They are poor investments, unless you have some special insight into their performance in the short-term and you are playing them for the short-term only. Avoiding TIPS is a prudent course of action.

Source: TIPS Are Tipped Against You