Understanding TIPS Funds: A Guide to Inflation-Protected Income

TIPS fixed income funds are a type of investment that many people turn to in order to provide a regular income. The underlying security for this type of mutual fund is TIPS, which stands for "Treasury inflation-protected securities." Here are the basics of the TIPS fixed income fund.

TIPS

Treasury inflation-protected securities are a type of investment that is offered by the United States Treasury. The idea behind this type of security is that you can invest in it, and it will keep up with inflation. The Treasury will adjust the principal of the security periodically in order to keep up with changes in the Consumer Price Index. On top of the principal adjustments, the Treasury also pays a specific coupon payment to the investor. This provides you with a fixed income that is based on the principal amount.

Benefits of TIPS Fixed Income Funds

Investing in this type of fixed income fund can provide you with several benefits. For one thing, you will be able to guarantee yourself a regular income. An investment in the Treasury is one of the safest types of investments currently available. You know that they are not going to default on the debt and will continue to make payments.

Another advantage of this type of investment is that you can benefit from professional management. You do not have to worry about making the individual decisions as to when to buy and sell these securities. You can leave that up to a professional money manager that has a great deal of experience in this matter. He or she will try to find underpriced TIPS that the fund can buy to add more value to the portfolio.

By investing in this type of fund, you will also have diversification on your side. As an individual investor, you will be able to purchase only a certain number of TIPS. With a fund, the fund manager can purchase many different TIPS with varying maturity dates. This provides diversification that you cannot get by yourself. 

With this type of investment, you will also have the option to automatically reinvest in the fund. When you do this, you will not have to worry about a sales charge or any other fees.

Drawbacks of TIPS Fixed Income Funds

One of the big potential drawbacks of this type of investment is that you have to pay management fees. Since a professional money manager is in charge of what goes on, he or she has to be compensated for his or her expertise. This comes in the form of an expense ratio, and it comes directly out of the fund's profits. Over the long term, this can significantly eat into your returns.

Another potential disadvantage of putting money into this type of fixed income fund is that your money could do better in another type of fund. A TIPS fixed income fund will generally only barely beat the inflation rate. By investing in an equity fund, you could do much better than that.