Diane Anderson: ‘Please reconsider your recommendation on TIPS [Treasury Inflation Protected Securities]. I’ve been strongly pro-TIPS, but I’ve changed my mind based on their huge run-up over the last 1-1/2 years.’
☞ I haven’t recommended them in a while, because I agree. Recommended here more than once, when they were trading around par (100 cents on the dollar), today they are around 123, meaning a 23% gain in the last year, plus the 3.375% interest they were geared to pay at par, plus the slight accretion for inflation. Not bad for the safest investment on the planet!
But at 123, the roughly $33.75 interest you get on each bond no longer works out to 3.375%, but, rather, to more like 2.25% as the yield to maturity. That’s because you have to pay $1,230 or so to get the $33.75, not $1000 (which works out to 2.75% interest) . . . and because (if there were no inflation) the bonds would eventually be redeemed in 2032 at $1,000, not the $1,230 you paid (which chips away at the compounded annual return still further, bring the YTM down to about 2.25%).
Of course there likely will be inflation, which these bonds protect you against, which is what makes them so appealing. But when you pay so much for them today, your overall return will be lower than if you had bought them at par, when first recommended. I’ve sold a chunk of mine, planning very possibly to buy them back lower, if they go lower.