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A while back I moved a portion of my wealth into inflation protected bonds as I needed a store of value that could preserve my purchasing power through the current high rates of inflation we were seeing. I ended up buying VTIP, the Vanguard ETF with TIPS of 2.5 year average maturity.

I am struggling to understand how its price is tracking with inflation and rates/yields. So far it's been fairly flat i.e. hasn't really gone up in value to track the high rates of inflation of 2021 and all I'm seeing is now they lose value in response to rates rising. While I expected the latter and kept the maturity at 2.5 years to cap interest-rate related drawdowns, I am not understanding the former.

Would appreciate any insights on this. I had a specific goal in purchasing this TIPS ETF and I have unfortunately failed :(

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TIPS are only inflation protected if you (or the ETF) holds them to maturity, and the average maturity in VTIP is 2.5 years, so many of those TIPS won't have matured yet (and VTIP will keep rolling them over). Before they mature, the actual price of each TIPS bond is going to fluctuate, and that's reflected in the NAV of the ETF.

This answer talks a little about the difference between a TIPS and a CD over the life of the instrument (before maturity).

The amounts you can buy each year are smaller, but have you considered I Bonds?

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  • Thanks Michael. The description sounds unintuitive. If the underlying bonds are trading on the market then the increase in principal should be priced in even if it's only paid at the end of the term. Otherwise when vanguard rolls the underlying over someone can make free money by buying and holding it and then getting a guaranteed return as they know that 2021 inflation was 5% more than what was priced in at the time. How does this reconcile with your answer?
    – David Karam
    Commented Jan 23, 2022 at 2:41
  • @DavidKaram I think your expectation was that buying a TIPS ETF would function similarly to if you bought TIPS themselves, of the same or similar duration to those held in the ETF, and held them to maturity, right? Because this is not the case. iShares has a useful table that breaks down the differences here: ishares.com/us/literature/brochure/mechanics-of-tips-en-us.pdf
    – Michael A
    Commented Jan 23, 2022 at 15:43
  • In short, the share price of the TIPS ETF is not equivalent to the principal value of the TIPS it holds, and the TIPS ETF is not of fixed duration, unlike TIPS you buy through TreasuryDirect and hold to maturity.
    – Michael A
    Commented Jan 23, 2022 at 15:46
  • Oh wow, this is so sad, I very deeply misunderstood how a TIPS ETF functions. The "priced in" aspect of it is actually disbursed as dividends, now I am looking at the statements and I do indeed see that they returned the 4.7% avg. inflation of 2021. The big problem though is that it's considered income which for me is taxed at 40%+ marginal, meaning I only really track at half of inflation. So I got it directionally right but tactically wrong. This is super misleading and makes TIPS a far less than ideal hedge against inflation. Thanks a ton for the tips (wordplay :)
    – David Karam
    Commented Jan 24, 2022 at 4:04
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    Why are you taxed at 40% plus your marginal rate? And wouldn't you rather make more money even if you pay more tax? Meaning, would you rather make $100 and pay $50 in tax or make $200 and pay $100 in tax?
    – D Stanley
    Commented Jan 25, 2022 at 20:58
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TIPS (and the ETFs that hold them) protect against unexpected inflation. IF you buy an individual TIPS bond, you are guaranteed a real rate of return - meaning the principal of the bond is increased with inflation. But they are priced based on the market's expectation of inflation - so they only go up in value if inflation is higher than expected. You pay a premium upfront to guarantee a real rate of return.

Since many people have been expecting inflation to increase ever since stimulus payments started, it's not surprising to see that their market value is flat.

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  • Thanks D. That makes a lot of sense. I have been holding them for a while though, long before anyone expected inflation to go so high in 2021. And the disbursements through dividends I mentioned in the comments above are actually consistent with the inflation numbers coming out. I'm still trying to reconcile both price movements that correspond to rates and expectaitons of rates and the dividend payouts corresponding to the phantom income that ETFs disburse vs. actual TIPS. I'll post an update again here for others once I've teased the two out in my head and in my portfolio.
    – David Karam
    Commented Jan 25, 2022 at 22:17

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