Tips For Investing In Fidelity: A Guide

Treasury Inflation-Protected Securities (TIPS) are government bonds that protect your principal investment and guarantee returns that keep pace with inflation. TIPS can be purchased directly from the government via the TreasuryDirect website, but only if they are held in a non-retirement account. Alternatively, you can buy TIPS at auction by placing an order through an online broker such as Fidelity or Schwab. These auctions take place in January, April, July, and October, and the maturities are for 5, 10, and 30 years. This option typically provides the best price, and online brokers usually charge little to nothing for the transaction.

TIPS vs. stocks: the pros and cons

Treasury Inflation-Protected Securities (TIPS) are a type of US Treasury bond designed to protect investors against inflation. They are indexed to inflation and have a fixed interest rate, which is paid out semi-annually. The dollar amount of the interest payment adjusts every six months according to changes in the Consumer Price Index (CPI).

Investing in TIPS can be a good way to protect your portfolio against inflation, but they are generally seen as a wealth protection tool rather than a wealth-building instrument. Here are some of the pros and cons of investing in TIPS compared to stocks:

Pros of TIPS:

• Inflation Protection: TIPS provide a hedge against inflation by adjusting the principal and interest payments based on changes in the CPI. This helps investors maintain their purchasing power when prices are rising.
• Principal Protection: When you buy a TIPS bond, you are guaranteed to receive its full face value at maturity, even if there is deflation.
• Tax Advantages: Interest income from TIPS is exempt from state and local income taxes, although it is subject to federal income tax.
• Low Credit Risk: Since TIPS are backed by the full faith and credit of the US government, they are considered to have low credit or default risk.

Cons of TIPS:

• Underperformance: TIPS have historically underperformed stocks in the long run. They are not considered a primary vehicle to build wealth, but rather a tool to protect wealth.
• Interest Rate Sensitivity: Like other bonds, TIPS are susceptible to fluctuations in interest rates, and their prices will typically decline as rates rise.
• Volatility: TIPS can be volatile, especially when held through mutual funds or exchange-traded funds (ETFs). Unlike individual TIPS bonds, these funds do not have a maturity date, so investors are subject to price risk when cashing out.
• Inflation Measurement Discrepancy: There is a risk that the official CPI fails to accurately track actual inflation or the rising prices of the specific products and services an investor needs.

While TIPS can provide valuable inflation protection, stocks may offer better long-term returns and are a more effective tool for building wealth. However, it's important to note that stocks also come with their own set of risks, including market volatility and the potential for capital losses.

How to buy TIPS at auction

Treasury Inflation-Protected Securities (TIPS) are bonds that protect investors against inflation. The principal of a TIPS bond can go up or down over its term, depending on whether there is inflation or deflation. When a TIPS bond matures, investors receive either the inflation-adjusted principal or the original principal amount, whichever is greater. TIPS pay a fixed rate of interest every six months until maturity, and interest payments are based on the adjusted principal.

• Understand the auction process: TIPS are sold at auction by the US government. The auction schedule can be found on the US Treasury website. Auctions are typically held throughout the year for TIPS with maturities of 5, 10, or 30 years.
• Decide on the type of bid: There are two types of bids in a TIPS auction: non-competitive bids and competitive bids. Non-competitive bids allow you to purchase TIPS at the average auction price, with a limit of $10 million per household. Competitive bids require you to specify the yield you are willing to accept, and you can bid up to 35% of the offering amount.
• Place your bid: You can place your bid through Fidelity, either online or through a representative. If you place your bid online through Fidelity.com, there are no fees. However, if you place your bid through a representative, a service fee of $19.95 will be charged.
• Review the auction results: After the auction, you will find out if your bid was successful. The rate for TIPS is fixed at auction and can never be less than 0.125%.
• Manage your TIPS: Once you have purchased TIPS, you can hold them until maturity or sell them on the secondary market. TIPS can be traded electronically, and you can use tools like the Mutual Fund and ETF evaluators on Fidelity.com to research and manage your investment.

Buying TIPS on the secondary market

However, when buying on the secondary market, you will pay more due to the bid/ask spread. The cost of purchasing TIPS on the secondary market is determined by the par value, coupon rate, real yield to maturity, inflation index, adjusted principal, cost factor, and investment cost.

The par value is the base amount of the TIPS you are purchasing, while the coupon rate is set by the original TIPS auction and determines the annual interest your TIPS will earn. The real yield to maturity is the amount you will earn above official US inflation, locked in once you make your purchase. The inflation index reflects the accrued inflation already earned by the TIPS, which is usually above 1.0 on the secondary market.

To calculate the adjusted principal, you multiply the par value by the inflation index. The cost factor is then determined by dividing the ask price by 100, resulting in a dollar-for-dollar multiplier. Finally, the investment cost is calculated by multiplying the adjusted principal by the cost factor.

It is important to note that the accrued interest will be added to the investment cost at settlement, reflecting any unpaid coupon interest up to the settlement date. This amount is generally small and will be returned to the investor at the next coupon payment.

When considering buying TIPS on the secondary market, it is crucial to evaluate multiple factors, including the market real yield for the desired maturity, the impact of inflation-accrued principal, the premium price for inflation-accrued principal, and the coupon rate. Additionally, it is worth assessing whether a higher real yield to maturity is the primary decision-making factor or if other factors also carry weight.

TIPS funds and ETFs: the pros and cons

Treasury Inflation-Protected Securities (TIPS) are a type of US Treasury note that adjusts for inflation. The principal amount and interest payments on TIPS rise along with inflation and are adjusted according to the Consumer Price Index (CPI). TIPS can be purchased directly or through funds and ETFs. Here are some pros and cons of investing in TIPS funds and ETFs:

Pros:

• Protection against inflation: The value of TIPS and associated interest payments increases with inflation, protecting against the erosion of purchasing power.
• Low default risk: TIPS are backed by the full faith and credit of the US government, making them a relatively low-risk investment.
• Diversification: TIPS funds and ETFs provide exposure to a basket of TIPS securities, diversifying your investment across multiple maturities and reducing the risk of investing in individual securities.
• Tax advantages: Interest income from TIPS is exempt from state and local income taxes, although it is subject to federal income taxes.
• Liquidity: TIPS are highly liquid, with large volumes traded throughout the day by various institutions, foreign governments, and individual investors.

Cons:

• Lower yields: TIPS typically offer lower interest rates compared to other securities due to their low default risk.
• Interest rate risk: TIPS are susceptible to fluctuations in interest rates, with longer-term securities being more volatile.
• Shutdown risk: While rare, there is a risk that a TIPS ETF may close, requiring shareholders to reinvest their money and potentially triggering unexpected taxes and fees.
• Limited diversification: Some TIPS funds and ETFs may only invest in large-cap stocks or specific sectors, limiting exposure to mid- and small-cap companies and potentially reducing overall diversification.
• Trading costs: Financial institutions may charge commissions or fees for buying or selling TIPS ETFs, and less frequently traded ETFs may have wider bid-ask spreads, impacting the price you pay.

How to buy individual TIPS in an IRA

Treasury Inflation-Protected Securities (TIPS) are a type of Treasury security issued by the US government. TIPS are indexed to inflation to protect investors from a decline in the purchasing power of their money. As inflation rises, the yield on TIPS does not increase; instead, they adjust in price (principal amount) to maintain their actual value.

You can buy individual TIPS through Fidelity in your IRAs. Here's how to do it:

Step 1: Log in to your Fidelity account

Using your login credentials, access your Fidelity account.

Step 2: Navigate to the "Fixed Income, Bonds, and CDs" section

From the homepage, go to "News & Research," then click on "Fixed Income, Bonds, and CDs."

Step 3: Click on the "Bonds" tab

This will bring up a list of different types of bonds offered by Fidelity.

Step 4: Select "U.S. Treasury"

Here, you will find additional choices for "TIPS (Auction)" or "TIPS (Secondary)." You can use the "Attributes Legend" at the top of the page to learn more about these options.

Step 5: Place your order

You can place an order for secondary market TIPS on Fidelity.com during the standard market session, which is generally 8:00 a.m. to 5:00 p.m. ET. Alternatively, you can enter an auction order, but these follow a specific cycle for when you can place your order. Check the tentative auction schedule for more information.

It's important to note that while you can transfer TIPS from a Treasury Direct account to your taxable Fidelity brokerage account, you cannot put them in your IRA if they were originally purchased outside of an IRA. Therefore, if you want individual TIPS in your IRA, you should purchase them directly through your Fidelity account.

Frequently asked questions