The best way to own TIPS

Question: Are there any disadvantages to purchasing TIPS through something like Fidelity's Inflation Protected Bond (FINPX) for my Roth IRA? Or would it be a better idea to just purchase TIPS directly from the Treasury? Thanks, Danny, Davis, CA

Answer: There is a difference between owning individual Treasury Inflation Protected Securities and owning them through a mutual fund. The individual TIPS offer a better hedge against inflation. TIP mutual funds and exchange traded funds (ETFs) are convenient to own. It's a basic trade-off.

You can't buy TIPS yourself directly from Treasury for your IRA. The rules prohibit it. (You can purchase TIPS directly from the government through a taxable account.) However, you can buy TIPS at auction by placing an order through an online broker such as Fidelity or Schwab. The TIP auctions are in January, April, July and October. The maturities are for 5, 10 and 30 years. You get the best price this way. Online brokers will charge you somewhere between nothing and little for the transaction.

You then own and hold your inflation hedge. Now, you can buy TIPS that have already been issued through a broker on the "secondary market." It isn't recommended for market novices and for smaller sums. "TIPS are also available on the secondary market, but we do not recommend that you go there unless you have a great deal of experience," write Zvi Bodie and Rachelle Taqqu in Risk Less and Prosper: Your Guide to Safer Investing. "It won't be possible, otherwise, to gauge how reasonable a deal you are being offered."

The advantage of the TIP funds and TIP ETFs is the ease of buying and selling, low fees on most funds, and the automatic reinvestment of dividend income. Problem is, like all bond funds, the net asset value of the TIP fund fluctuates. It also doesn't mature at the point you want to cash in your inflation hedged investment. Like all bond funds, the value of the TIP fund will fall if interest rates rise, and vice versa. There is less of a match with inflation. Nevertheless, funds still give you a measure of protection against rising prices depreciating the value of your savings.

Before you act, I would read Chapter 7 of the book I quoted from, Risk Less and Prosper. In the chapter on "Finding the Safe Investment Zone," the authors go into detail about buying TIPS and the trade-offs with the various options.

 

About the author

Chris Farrell is the economics editor of Marketplace Money.

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