Top TIPS: treasury inflation-protected securities explained

James McManus


2 min read

US Treasuries are some of the safest assets around. Treasury inflation-protected securities have the added benefit of protecting investors from rising consumer inflation.

Man and woman walking under umbrella

The market for US Treasury securities — government bonds issued by the United States — is among the largest and most liquid financial markets in the world. Treasuries are regarded as some of the safest assets an investor can purchase as they’re backed by the ‘full faith and credit’ of the US government, which in turn is one of the most creditworthy lenders globally.

Bear in mind though that, despite these treasuries being issued by the United States government, they are not free of risk — they are still investments and, as with all investing, therefore have a level of risk associated with them.

The Treasury market is also critical to the operation of other global assets markets, as interest rates on Treasuries provide an indication of the basic level of return that investors require to invest.

Treasury securities defined

The US government issues four primary types of Treasury securities.

Treasury bonds: T-bonds have the longest life span before investors could potentially receive their initial investment back (known as maturity). Maturities for T-bonds range from 10 to 30 years, and the bonds pay interest twice a year.

Treasury notes: T-notes are similar to T-bonds as they also pay interest twice a year. But they have maturities ranging between 1 and 10 years.

Treasury bills: T-bills are very short-term securities that mature in one year or less from their time of issue, typically with three month, six month or one year timeframes. Unlike other Treasury securities, they don’t pay interest regularly but instead are purchased for a discount to their maturity price (in effect your interest is paid to you along with your initial principal in one lump sum when the T-bill matures).

Treasury inflation-protected securities: TIPS, also known as inflation-linked bonds, can have a range of maturities from 5 to 30 years. TIPS are unique in the Treasury market as they offer investors both the credit worthiness of the US government, and protection from rising consumer inflation.

How do TIPS work?

Like most bonds, TIPS require an initial investment which is later repaid with interest (although of course, as with all investing, there is risk associated with these bonds) by the issuers of the bond — in this case, that’s the US government. However, unlike most bonds, the value of TIPS rises or falls with inflation, while the interest rate remains fixed.

So in an environment of rising inflation, the investment will keep pace with inflation and retain its purchasing power and, while the interest rate remains constant, the rate is applied to the higher investment amount. The inverse is true should inflation fall – the investment will be adjusted down and the interest rate applied to the new, lower value.

When a TIPS reaches maturity, the investor is paid the greater of either the original investment, or the inflation-adjusted investment. This means that should inflation fall, an investor who holds the security to maturity will never receive less than their initial investment.

Read about how we’re preparing Nutmeg portfolios for rising inflation by investing in TIPs.

Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.

 

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James McManus

A self-confessed ETF geek, James is head of ETF research at Nutmeg. He joined in 2015 from Coutts & Co, where he was an associate director in the investment office. James holds a Bsc (Hons) in International Business from Nottingham Business School.


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