Treasury Inflation-Protected Securities (TIPS) are a type of U.S. Treasury bond that is indexed to inflation. They are designed to protect investors against inflation by adjusting the principal value and interest payments based on changes in the Consumer Price Index (CPI). When inflation goes up, the principal value of TIPS increases and the interest payments also rise.
TIPS work differently from traditional bonds because they provide a hedge against inflation. With traditional bonds, the fixed interest rate and principal value remain constant over time, which means that inflation erodes the purchasing power of the bond’s interest payments and principal value.
In contrast, TIPS adjust for changes in inflation, ensuring that investors receive a return that keeps pace with rising prices.
Here’s a summary of how TIPS work:
- Investors purchase TIPS from the U.S. Treasury either directly through TreasuryDirect.gov or through a broker.
- TIPS pay interest semi-annually at a fixed rate determined at the time of issuance. The interest rate is applied to the adjusted principal value.
- The principal value of TIPS is adjusted based on changes in the CPI, which measures the average change in prices of goods and services.
- When the CPI increases, the principal value of TIPS is adjusted upward. As a result, the interest payments also increase.
- If inflation is negative (deflation), the principal value of TIPS is adjusted downward. However, at maturity, investors are guaranteed to receive either the adjusted principal or the original principal, whichever is greater, protecting their initial investment against deflation.
- TIPS have different maturity terms, including 5, 10, and 30 years.
Investing in TIPS can be seen as a way to preserve the purchasing power of your investment during inflationary periods.
However, it’s important to note that TIPS typically offer lower interest rates compared to other government or corporate securities at the time of issuance. Also, the value of TIPS can still fluctuate in response to changes in interest rates and market conditions.
If you’re considering investing in TIPS, it’s recommended to do thorough research, consult with a financial advisor, and assess your own investment goals and risk tolerance.