TIPS (Treasury Inflation-Protected Securities)

Protection built into the principal

Treasury Inflation-Protected Securities, first issued in 1997, work like ordinary Treasury notes and bonds with one crucial difference: their principal is adjusted for inflation using the Consumer Price Index. If prices rise 3 percent, the principal rises by about 3 percent as well.

TIPS pay a fixed interest rate twice a year, but the rate is applied to the adjusted principal, so the payments grow with inflation too. They are issued with maturities of five, ten and 30 years.

The deflation floor

If prices fall, the principal is adjusted downward. At maturity, however, investors receive at least the original face value, so a long bout of deflation cannot leave them with less than they lent.

What their yields reveal

Because TIPS already compensate for inflation, their yield is a real interest rate. Comparing it with the yield on an ordinary Treasury of the same maturity gives the breakeven inflation rate: roughly the average inflation investors expect over that period. Central banks and economists watch it as a market-based gauge of inflation expectations.

Why the government issues them

For the Treasury, TIPS widen the pool of buyers, especially pension funds and others with inflation-linked obligations. They can also save money if inflation turns out lower than markets expected when the securities were sold.

The trade-off is that the government takes on inflation risk. When inflation surged in 2021 and 2022, the adjustments on outstanding TIPS added substantially to federal interest costs. TIPS are a relatively small share of marketable debt, but they tie part of the budget directly to the price level.

For individual savers

TIPS can be bought at auction through TreasuryDirect or through a broker. Inflation adjustments to the principal are generally taxable in the year they occur, even though the money is only received at maturity, which is why many investors hold TIPS in tax-advantaged accounts.