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TIPS Beat I Bonds as Inflation Hedge Investment Today

There are several differences between TIPS and I Bonds, and Treasury Direct has a chart comparing the two. Unlike I Bonds, TIPS can be bought and sold on the open market. They can also be purchased through any brokerage platform, such as Fidelity, Schwab or Vanguard, but, like I Bonds, they can also be purchased from Treasury Direct. Unlike I Bonds, TIPS can be purchased in retirement accounts like IRAs. For all practical purposes, there are no limits to how much money you can put in TIPS beyond the $10,000 limit a person can buy each year in electronic I Bonds.

Both I Bonds and TIPS are adjusted for inflation using the CPI, although TIPS are adjusted monthly while I Bonds are adjusted semiannually. Unlike I Bonds, you can see the current value of your TIPS whenever the market is open, though I strongly suggest you not look. You already know what your real, inflation-adjusted return will be if you hold to maturity.

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David Enna, founder of Tipswatch.com, points out some disadvantages to TIPS relative to I Bonds. The largest is taxes. Interest from I Bonds is tax-deferred until you cash them in. With TIPS, you pay taxes on the interest annually, and to make matters worse, the IRS also taxes you on the inflation component — even though you didn’t actually receive the cash. Holding TIPS in an IRA solves this problem. Enna notes that I Bonds can be used tax-free to pay for educational expenses in some circumstances, whereas TIPS cannot.

Which are better today? Harry Sit, founder of TheFinanceBuff.com, told me that now “TIPS are a better value for the long term at the current real yield of about 1.6 percent.” Enna says, “At this point, I’d prefer a five-year TIPS over an I Bond to be held for five years.”

For me, I also think TIPS are generally superior to I Bonds right now, since they provide a greater yield. But that could change at some point. If, like at the beginning of the year, I Bonds begin yielding more than TIPS, I’d prefer I Bonds again. But for now, TIPS provide a greater return.