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Q&A: Should I Buy a 30-Year TIPS?

Q: I have a TIPS which will mature next year. Should I sell it now and buy a 30-year TIPS?
A: If you have a TIPS maturing next year that you can sell without incurring high transactions costs, I do think it makes sense to consider moving out to a longer maturity TIPS. The primary reason to consider doing this is that the TIPS yield curve is extremely steep right now. For example, the one-year TIPS yield is currently about -2.3 percent, while the 30-year TIPS yield is at roughly 1.9 percent. This means that yields increase by more than 4 percent going from one-year to 30-year maturities.

Keep in mind though that moving out in maturity, (especially to a 30-year maturity), means you're taking on substantial real interest rate risk. There's nothing wrong with this per se, but just something to consider. To put this in perspective, if real interest rates were to move up by 1 percent, you could expect the price of the 30-year TIPS to fall by 20 percent or so.

Two other points to consider: The first is that one of the major advantages of TIPS is that you can extend maturity and earn the term premium without taking the risk of unexpected inflation that you take when you extend maturity with nominal bonds.

The second is this: Extending maturity seems to make sense right now given the current very steep TIPS yield curve. Having said that, given that TIPS yields are still well below historic average yields, you may want to consider limiting maturity to the 15-20 year period, rather than extending all the way to 30 years. This isn't a recommendation against the 30-year, but just a suggestion to at least consider the alternative.

If you have a question you would like to have answered, please submit it using this blog's contact form. Please note that Larry will try to get a response back to you, even if your question doesn't appear on the blog.
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