The Big Difference Between I-Bonds and TIPS.

This article was posted on November 1, 2002.

Series I Savings Bonds (I-Bonds) and Treasury Inflation Protected Securities (TIPS) both protect investors against the ravages of inflation. They are both available from the US Treasury's Department of Public Debt. You may buy I-Bonds on-line from Savings Bonds Direct or at your local bank without fees or commissions. TIPS may be bought through Treasury Direct at auction without fees or commissions. They may also be obtained from a bank or brokerage firm at a small commission.

Many investors don't realize that there is a big difference in the way I-Bonds and TIPS perform during periods of deflation. I-Bonds lock in the value of the bond every 6-months and won't allow the accumulated inflation-adjusted value to decline below that. In other words, the combined rate of coupon interest and inflation may never go below 0%.

If you sell an I-Bond before maturity you get the accumulated value. The only exception is that if you own an I-Bond for less than 5 years when you sell it, you pay a penalty of the last 3 months interest.

TIPS on the other hand may erode the accumulated value of the bond during extended periods of deflation, although they do guarantee the return of your original investment at maturity. There is no guarantee on the sale price of a TIPS before maturity. You may get more or less than the calculated value of the bond in the aftermarket. This snapshot of an Excel spreadsheet illustrates the point, click here. If you want to run your own inflation/deflation scenarios, you can download a copy of the Excel spreadsheet. Click here.

For more information on TIPS see:

http://www.publicdebt.treas.gov/sec/seciis.htm

http://www.clev.frb.org/research/com97/0701pr.htm

http://www.cradv.com/tips.pdf

http://institutional.vanguard.com/Institutional/TrustOfficers/tisfundscope_fall2000.html

For more information on I-Bonds see:

http://www.publicdebt.treas.gov/sav/sbifaq.htm#sbifaq1