"What are the Risks of TIPS :: Treasury Inflation Protected Securities"

Strictly speaking, because they're backed by the full faith and credit of the United States government, Treasury Inflation Protection Securities are risk-free.

Of course, in real life there's no such thing as a risk-free investment.

The government has the power to tax -- but what if there's a severe depression and inflation and most taxpayers are broke?

The government has the power to simply print up money, but that increases inflation . . . and TIPS require a payment of inflation PLUS the coupon interest rate.

Besides, you can't read the newspaper these days without realizing that the United States has many external (and internal) enemies. This is not the place to expound upon these threats. Let's just say that I hope that the enemies of freedom don't win -- but the U.S., along with Canada, Europe, Australia and New Zealand are targets.

Another risk of TIPS is that if 70s-style inflation ever comes back into the economy, TIPS could become TOO popular!

That is, so many people start buying them to protect their spending power, that increasing the principal by a high rate of inflation becomes too much of an expense for the government's budget.

If the government thinks that the taxpayers can no longer afford to pay TIPS owners interest plus an inflation-adjustment of their principal, it may cut the TIPS program back or eliminate it.

The good news is that they almost certainly would "grandfather" or honor the terms of current TIPS.

So this is just an argue for buying TIPS now instead of waiting for a period of high inflation.

(Given the extreme price increases recently of oil, gold and other commodities, plus the weakness of the dollar -- high inflation is not impossible in the near future.)

There is also the risk of deflation

The principal of TIPS goes up with inflation. I don't think we've had a year of an actual decrease in the Consumer Price Index since the Great Depression of the 1930s. However, it's not impossible. There are some compelling arguments in favor of deflation.

If deflation should occur, your TIPS principal would go down the same percentage.

However, at maturity a TIPS owner is paid at least the original face value. Therefore, over the entire life of the bond, you cannot lose the face value. This protects you from deflation from issuance through maturity, though not from price fluctuations prior to maturity.

Next: What are the disadvantages of TIPS

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