Have TIPS in your 401(K)

Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds designed specifically to protect investors against inflation. Both the interest and the principal payments are indexed against the Consumer Price Index (CPI). Real yields on Treasury TIPS (Treasury Inflation Protected Securities) at "constant maturity" are interpolated by the U.S. Treasury from Treasury's daily real yield curve. Like other Treasuries, TIPS pay interest every six months and pay the principal when the security matures. The difference is that the coupon payments and underlying principal are automatically increased to compensate for inflation.

Regular treasury yield has a fixed relation with TIPS’ yield. Treasury yield = TIPS yield + expected inflation. When the actual inflation is believed to be greater than the expected inflation, TIPS becomes more valuable because TIPS is more protected.

TIPS take about 11% of marketable Treasurys outstanding. Recently, a 10-year TIPS yield is between 2-2.5%, but a regular 10-year Treasury yielded about 0.5% more. That means the expected inflation is only 0.5% per year, or almost no inflation.

When the current administration passed a slew of new regulations and stimulus plans and treasury buyback, such inflation expected is slated to be changed. Bill Gross wrote in a Brron’s article expecting TIPS would rise in the middle of 2009 by 20%.

TIPS is open to public, especially for conservative investors. Besides you can go directly to federal government for TIPS, many 401(k) plans have TIPS mutual funds options. Considering wild volatility in other options, limited supplied options in 401(k), and expected rising inflation therefore rising value in TIPS, it is a good option to put it in your 401(k). For example, State Street Global’s (SSgA) TIPS index fund had a slight decline in 2008 but it is climbing up in 2009’s first 3 month.