fatpitch2

TIPs to Protect Yourself from Future Inflation

Annette:

The simple answer to your question is "no" if you went into the market right now and bought some TIPS you most likely NOT get 8% annually, and the returns WILL most certainly fluctuate.

TIPS have a coupon rate (nominal interest payment made) and then
TIPS bonds' principal is linked to changes in the Consumer Price Index (up or down) and can provide an effective hedge against inflation in an investor's portfolio relative to standard Treasury bonds. As CPI rises, the principal in the individual TIPS bonds is adjusted upwards. The nominal/coupon interest on the bond is then paid on the higher principal, which raises the overall effective yield of the security.

Also, note that inflation is just one component of interest rates and that changes in the "real rate" or the risk free cost of capital will cause the value of TIPS bonds to oscillate up or down just like Treasury bonds. It is also important to note that because of the inflation adjustment on TIPS, the yield you get today is not set in stone and investors should be prepared for it to move up or down depending on the movements of the CPI.

It is more complicated than it appears at first glance.... but there are many good articles explaining how the work ... far better than I can do here...

TIPs to Protect Yourself from Future Inflation

Like other bonds the nominal return on TIPs (the part not connected to inflation) has been dropping. Take a look here: www.treasurydirect.gov...

For example it appears the last 5-yr note auction offers only 2%.

Yes, the TIP is inflation adjusted, but since the adjustment factor is based on the CPI which, at least I think, understates inflation you may not be doing all that well. That is to say that a 2% nominal return with a CPI adjustment that does not really make you "whole" from an inflation standpoint may not look so hot if inflation rates start rising....

Comments?

I do currently hold the Vanguard TIP fund in my 401k to keep the taxes simple, but I am starting to question myself on this.......