These bonds are perfect for retirees — and are paying twice their historic average

By Brett Arends

TIPS have suddenly started offering the best deal in nearly a generation

I'm not even retired and I've been buying long-term inflation-protected U.S. Treasury bonds in my 401(k) with both hands.

Thanks to the recent turmoil in the Treasury market, inflation-protected Treasurys--known as TIPS--have suddenly started offering the best deal in nearly a generation.

And although anyone trying to predict the future needs their head examined, if history is any guide they're a bargain. They are now paying about twice what you'd expect from the past 100 years.

TIPS are the forgotten cousins of the Treasury market. Their coupons and price adjust to reflect inflation, so that anyone who buys a bond and holds it until it matures is guaranteed a rate of return in "real," inflation-adjusted, purchasing power terms.

Read: I'm 49, have $1.2 million in savings and just lost my job -- can I trust the retirement calculators that tell me it's OK to retire?

That makes them hard to understand for both laypersons, who misunderstand their apparently low interest rates, and Wall Street types, who need regular, "nominal" numbers to plug into their Excel spreadsheets. It also makes them appear uninteresting to two generations who have never experienced sustained inflation, but only deflation.

John Coumarianos, a financial adviser in Northvale, N.J., says when he tries to talk about TIPS with clients "their eyes glaze over."

More's the pity, because as everyone has been forcefully reminded over the past two years what matters aren't "nominal," or headline returns but "real" returns after adjusting for inflation. If you earn 5% on your bonds and your expenses rise 8% you aren't really making 5%, you're losing 3%. Booyah!

TIPS yields are always quoted as inflation plus. A TIPS yield of 0.5% doesn't mean you'll earn 0.5% on your bonds, it means you'll earn 0.5% plus whatever inflation is for each year of the life of the bond. So you can't compare the yield directly with that of regular bonds, whose yields are quoted regardless of inflation.

Last week the yield on TIPS bonds spiked to 2% (or higher) across the board, from the short-term bonds all the way out to the 30 years. In other words, you could buy bonds that guarantee you a return of inflation plus 2% a year for a full 30 years

Or, to put it another way, $1 invested in TIPS today is guaranteed to be worth $1.80 in real, purchasing power terms in 2053, regardless of what happens, come hell or high water. No inflation, deflation, depression, bear market, or panic will matter.

How good a deal is this? Well, TIPS bonds haven't been offering yields this good since 2009. They haven't consistently offered yields this good since before the financial crisis. Two years ago the yields were actually negative, meaning anyone buying TIPS was locking in a rate of return of inflation minus a certain amount. In late 2021 the 30 year TIPS yield was negative 0.6%: You were guaranteed to lose purchasing power, though by no more than 0.6% a year, for three decades.

Last year everyone was agog for "I bonds," a TIPS variant also offered by Uncle Sam, which were paying inflation plus 0%. Now TIPS are paying 2%.

TIPS have only been around since the late 1990s, so there's no long-term data on them. But we have long-term data on regular Treasury bonds, and on inflation. So I decided to run some numbers to see how today's yields compare.

Bottom line? They are somewhere between good and excellent.

On the one hand, since 1928, the annual return from regular 10 Year Treasury bonds has averaged 1.9% above inflation. That figure makes TIPS look good, but not amazing. But that figure grossly flatters the typical performance of bond investors over the past century. It is heavily skewed upwards by the small number of years when those real returns rocketed into double figures.

As usual, a better guide is probably the median return, meaning the one in the middle if you rank all the years from best to worse. By that measure, 10 Year Treasurys typically earned you only 1.5% a year above inflation.

But we don't buy Treasury bonds for one year. We usually own them for a decade, or several decades. And when we look at those numbers the past becomes startling. Since 1928, the median return from a portfolio of 10 Year Treasurys over any given 10-year period was just 0.85% a year above inflation, and the median return over any given 20 year period was just 0.98%. In other words, going back to the 1920s, and including booms, depressions, crashes, inflation, disinflation, deflation and wars, the typical investor in U.S. Treasury bonds ended up earning about 1% a year or less above inflation.

Today you can get 2%--and not just forecast, but guaranteed.

For technical reasons, to do with the way the Treasury treats the inflation adjustments, TIPS should be owned where possible in an IRA, 401(k) or other tax sheltered account.

There are two ways to invest in TIPS: You can buy individual bonds, or you can invest via a mutual fund or exchange-traded funds, such as Vanguard Inflation-Protected Securities (VAIPX), Schwab TIPS (SCHP), Pimco 1-5 Year TIPS (STPZ) for short-term bonds or Pimco 15+ Year TIPS (LTPZ) for long-term ones. Buying individual bonds can have certain technical advantages over buying a fund: You have greater control over exactly what you own, when it matures, and how much your return is. But it's also complicated, and the market can be surprisingly illiquid. (I own individual bonds, but then I'm a glutton for punishment.) Some people go so far as to construct a so-called "ladder" of individual bonds, meaning a portfolio of bonds that mature in successive years. But funds are certainly easier and simpler, and are probably the better option for most people.

Read more about TIPS ladders:Beating the 4% rule in retirement has become even easier

Nothing is certain. TIPS, having become cheap, could become cheaper still. If the bonds keep falling, and start offering 2.5% or 3% a year above inflation, you can have a good laugh at my expense. But I'm happy with 2%.

The way I see it, if inflation collapses TIPS are still bonds and their price is likely to rise, as they did during the bond booms of the past two decades. On the other hand, if inflation doesn't collapse sooner or later I figure Wall Street might stop ignoring the only thing that is guaranteed to protect you from it.

Wall Street still thinks inflation is going to average about 2.2% for the next five years and the next 10. We shall see. But for those of us who own TIPS, rather than regular bonds, it won't matter too much either way.

-Brett Arends

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08-26-23 0857ET

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