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Buying Treasury Inflation-Protected Securities As An Inflation Hedge


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Buying Treasury Inflation-Protected Securities | An Overview

Treasury Inflation-Protected SecuritiesTreasury Inflation-Protected Securities (TIPS), which are securities sold by the United States Treasury, obtain their valuation based on the official Consumer Price Index (CPI) inflation rate, and can be used as a way to hedge against future inflation.  Treasury Inflation-Protected Securities are a conservative low-risk investment that pay a fixed rate of interest that is based on the market rate set during their initial auction.  In addition to the interest paid, the underlying principal value of Treasury Inflation-Protected Securities rises in accordance with semi-annual inflation adjustments that are indexed to the Consumer Price Index inflation rate.

Treasury Inflation-Protected Securities have two primary disadvantages:  the interest rate paid is lower than many other types of similar investments (i.e. high grade bonds and treasury bonds) and the semi-annual inflation-based increase in the principal value is treated as taxable income for federal income tax purposes, even though the gains are not received by an investor until the Treasury Inflation-Protected Securities are sold or reach maturity.  Despite being subject to federal income taxes, gains associated with Treasury Inflation-Protected Securities are exempt from state and local income taxes.

When and How To Buy Treasury Inflation-Protected Securities

The ideal time to buy Treasury Inflation-Protected Securities is when inflation is low and is likely to rise or when an extended period of high inflation appears likely.  This is because Treasury Inflation-Protected Securities increase in value during periods of rising or high inflation, while other similar investments lose value relative to inflation.  The time not to buy Treasury Inflation-Protected Securities is when inflation is high and is expected to fall or is in the process of falling or when deflation is occurring, because other investments may offer much better returns during times of decreasing inflation or deflation, and Treasury Inflation-Protected Securities actually lose principal value when deflation occurs.

Treasury Inflation-Protected Securities can be purchased directly from the United States Treasury via the TreasuryDirect system.  Treasury Inflation-Protected Securities that mature in five, ten, or twenty years can be bought in $100 increments using TreasuryDirect.  For investors that do not wish to buy Treasury Inflation-Protected Securities directly, a number of mutual funds and exchange traded funds (ETFs) are available for purchase that derive their valuations based on Treasury Inflation-Protected Securities.  The advantage of buying Treasury Inflation-Protected Securities directly from the government is that fund management fees can be avoided; the disadvantage is that you have to make your own investment decisions, instead of leaving those decisions in the hands of seasoned investment professionals.

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