The Ins & Outs Of Having TIPS And/Or TIPS ETFs In Your Portfolio

Written by Matthew Tucker, CFA

Inflation expectations have been on the rise since before the U.S. election, but markets are now more convinced of higher inflation to come due to President-elect Trump’s talk of fiscal stimulus and tax cuts. Measured by break-evens in the Treasury Inflation Protected Securities (TIPS) market, inflation expectations for the next 10 years rose to 1.93%, the highest level since the summer of 2015... The long decline in inflation seems to be turning, as the Consumer Price Index (CPI) climbed 1.6% year-over-year, the most in two years... This changing environment has piqued investor interest in TIPS, and in turn, TIPS ETFs.

...TIPS:

  • can help protect investors against inflation, while also providing the potential for income.
  • payments are adjusted according to changes in the CPI...[which] means the coupon and principal payments of TIPS increase with inflation and fall with deflation...[and]
  • are also valued by investors for their historically low correlation with other asset classes, which can make them a good addition to a diversified portfolio.
  • can be bought directly through the government (the government sells them on TreasuryDirect.gov) or through an ETF.

Here are two key points to understand before deciding whether TIPS or TIPS ETFs are right for you:

1. Tax implications

For a taxable U.S. investor, both the bond coupon and the inflation adjustment of TIPS are taxed as income but the majority of the inflation adjustment is paid when TIPS mature. This creates what has been coined “phantom income”, income that is taxed in the current period but not received until a later period.

iShares offers two ETFs that invest in the U.S. TIPS market:

  1. iShares TIPS Bond ETF (TIP) and
  2. iShares 0-5 Year TIPS Bond ETF (STIP).

These funds address the phantom income issue by paying out a monthly distribution that includes both the coupon income coming from the underlying TIPS held in the funds, as well as the principal adjustment for inflation. The income that an investor is taxed on in the current period is received in the current period.

1 2
View single page >> |

This article may have been edited ([ ]), abridged (...) and/or reformatted (structure, title/subtitles, font) by the editorial team of munKNEE.com (Your Key to Making Money!) to provide a faster ...

more
How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.