How to get a guaranteed return of 1.3% per year above inflation

TIPS have become an increasingly attractive option in recent months 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 notes and bonds, except their quoted yields are above and beyond the Consumer Price Index. Real returns, in other words.

Right now, 10-year TIPS are yielding 1.29%, which means you’re guaranteed to earn at least a lot more than inflation over the next decade if you buy them today and hold them to 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 started rising 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 it has been in the last decade.

In fact, the positive real yield on TIPS makes them somewhat 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 IPC moving exchange rate and a fixed rate that you set when you buy. Although the US Treasury may change this fixed rate in the future, it is currently set at zero, meaning that the real yield on I-Bonds is precisely zero for now.

Because the fixed rate on I bonds is prevented from being negative, I bonds were more attractive than TIPS during periods in the last decade when TIPS real yields were negative. That situation has now been reversed.

To be sure, 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 to sell your TIPS on the secondary market before expiration, as they would now be trading above par, and where possible reinvesting the profits in I-Bonds at a real yield. zero.

sell before expiration

The only major risk in investing in a TIPS, therefore, is the possibility that you need to sell it before expiration and its yield is higher then than when you bought it. I-Bonds do not have that risk, since their value does not fluctuate; After an initial period where you can’t sell without penalty, you can sell your I-Bonds at any time at the same fixed (real) rate set when you bought them.

How big a risk do TIPS have over I-Bonds? As the accompanying chart illustrates, the 10-year TIPS yield is well above the 10-year average. Assuming your performance is mean-reverting, you may feel comfortable betting that it is more likely to be lower in the future rather 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 finance professor at Boston University, said in an email, “You can lose money on TIPS, but not on I-Bonds. With I-Bonds there is no downside risk…That is very valuable.”

In contrast, Harry Sit of The Finance Buff believes that TIPS are preferable at the moment. “When the 5-year TIPS yield is 1.27%,” Sit wrote in an email, “it’s hard to justify keeping the I-Bonds pegged at 0%.”

In any case, Sit added, “Since I-Bonds have a [purchase] limit, you do not 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 contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at [email protected]

Leave a Comment