Inflation Battle: TIPS vs. I-Bonds
After writing my summary of Berkshire Hathaway’s annual meeting, I realized that I didn’t really explain what Treasury Inflation-Protected Securities and Series I Bonds were, let alone which one is the better pick to battle inflation.
Both TIPS and I-Bonds are designed to do the same thing, though through different means.
When you buy TIPS:
– The principal (that is, the face value) of the bond is adjusted up with inflation or down with deflation.
– You receive a stated coupon rate, just like any other bond, but the interest payment is based on the adjusted principal, which means your payments can vary.
When you buy I-Bonds:
– The principal stays the same.
– The interest is a combination of the stated fixed rate and the inflation adjustment. In a deflationary period, the adjusted rate can go to 0%.
As luck would have it, the Treasury announced on Friday that Series I Bonds bought between now and Oct. 30 would return 0% — the first time a six-month period has had no return since the bonds were created in 1998.
That doesn’t mean the bonds aren’t working. It just means that right now, in the short term, we’re experience deflation. The Consumer Price Index, the government’s main measure of inflation, dropped at an annualized rate of 5.6% in the last six months.
If you’re deciding right now between I-Bonds and TIPS, and if you’re investing in a tax-deferred account, it’s best to go with TIPS. The easy reason is that TIPS are providing a real return (that is, a return after inflation) of 1.1% to 2.3% depending on the bond’s maturity date versus the 0% real return for I-Bonds. While the principal might get adjusted down in the shortterm, in the longterm, most investors and economists expect inflation to return with a vengeance, as the government pays for the stimulus program.
But if you’re investing in a taxable account, depending on tax considerations, you might want to stick with I-Bonds in the hope that their interest rate is adjusted up in November. As one of my colleagues at Money points out, while I-Bond interest is deferred for the life of the bond, the interest and principal growth of TIPS bonds are subject to federal tax, even if the bond hasn’t matured yet!
- Joe Light
