# What Are Treasury Inflation-Protected Securities (TIPS)?

> **Definition**
>
> Treasury Inflation-Protected Securities (TIPS) are a type of Treasury bond that is indexed to an inflationary gauge to protect investors from a decline in the purchasing power of their money.

Worried that inflation might eat away at your investment returns? Since you wouldn't be alone if you did, the U.S. Treasury created Treasury Inflation-Protected Securities (TIPS) in 1997—special government bonds designed to help protect investors when prices rise across the economy.

When inflation rises, both the principal amount you invested and the interest payments you receive increase to help maintain your purchasing power. This sets TIPS apart from regular Treasury bonds, whose payments stay the same—no matter what happens with inflation.

While TIPS typically offer lower initial interest rates than conventional Treasury bonds, they provide peace of mind for investors concerned about inflation's impact on their long-term savings.  

### Key Takeaways

*   TIPS adjust their principal value based on changes in inflation, as measured by the Consumer Price Index (CPI).
*   When inflation rises, both TIPS' principal value and interest payments increase to help protect your purchasing power.
*   Investors are guaranteed to receive at least their original principal back at maturity, even if deflation occurs.
*   TIPS typically offer lower initial interest rates than regular Treasury bonds in exchange for their inflation protection.
*   While intended for long-term inflation protection, TIPS can still lose value in the short term when interest rates rise sharply.

![Treasury Inflation-Protected Securities (TIPS)](https://www.investopedia.com/thmb/13XIhqPxHn4GYuQ1fafQnKT4RKQ=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/terms_t_tips_FINAL-211fcb82687c47ff918015e788914cff.jpg)

*— Daniel Fishel / Investopedia*

## Understanding Treasury Inflation-Protected Securities (TIPS)

The [principal](https://www.investopedia.com/terms/p/principal.asp) value of TIPS rises as inflation rises. Inflation is the pace at which prices increase throughout the U.S. economy, as measured by the [CPI](https://www.investopedia.com/terms/c/consumerpriceindex.asp). Inflation becomes an issue when there isn’t a commensurate rise in [real wage](https://www.investopedia.com/terms/r/realincome.asp) growth to offset the negative effects of rising prices.

TIPS are a popular asset for protecting portfolios from inflation because they pay interest every six months based on a fixed rate determined at the bond’s auction. However, the interest payment varies since the rate is applied to the adjusted principal or value of the bond. If the principal amount is adjusted higher over time because of rising prices, then the [interest rate](https://www.investopedia.com/ask/answers/032515/what-difference-between-real-and-nominal-interest-rates.asp) will be multiplied by the increased principal amount. As a result, investors receive higher interest or coupon payments as inflation rises. Conversely, investors will receive lower interest payments when there's [deflation](https://www.investopedia.com/terms/d/deflation.asp).

TIPS come in five-, 10-, and 30-year versions, all backed by the full faith and credit of the U.S. government. You can buy them directly through Treasury Direct for as little as $100, or invest through TIPS mutual funds and exchange-traded funds (ETFs), which offer easier trading but charge management fees. 

## TIPS and Inflation

Understanding how TIPS prices move with inflation is akin to watching a balloon inflate and deflate. When prices in the economy rise ([inflation](https://www.investopedia.com/articles/01/021401.asp)), the [par value](https://www.investopedia.com/terms/p/parvalue.asp) or principal of your TIPS investment expands. When (more rarely) prices across the board fall (deflation), your investment contracts, though it can't ever be smaller than the original size.

Say you invest $1,000 in a TIPS bond paying 1% interest annually. If there is no inflation as measured by the CPI, then you'll get $10 in coupon payments for that year. However, if inflation rises 2% during the year, your principal grows to $1,020. Your interest payment is then based on this new, higher amount. Instead of earning $10 (1% of $1,000), you'll earn $10.20 (1% of $1,020). This helps protect your purchasing power as prices rise.

But what happens in the historically rare circumstance that prices across the board fall—say 5%? In this case, your principal would adjust down to $950. Your interest payment would temporarily shrink to $9.50 for that year. However—and this is crucial—you're guaranteed to get back at least your original $1,000 at [maturity](https://www.investopedia.com/terms/m/maturityguarantee.asp), even after a period of falling prices.

One caution: While TIPS protect against inflation over the long term, they can still lose value if you need to sell them before maturity. Just like regular bonds, TIPS prices fall when interest rates rise, which is exactly what happened in 2022 when the U.S. U.S. Federal Reserve aggressively hiked rates to fight inflation. 

> **Important**
>
> TIPS don’t work as a short-term hedge against spikes in inflation. Their real function is to protect investors against rising living costs over the long term.

## How To Buy TIPS

As with other Treasury securities, investors can buy TIPS directly from the U.S. government at the Treasury website TreasuryDirect. This entails a login process with several security layers.

You can also buy TIPS directly from your bank or broker. This may be more convenient for those investors who already have a substantial [portfolio](https://www.investopedia.com/terms/p/portfolio.asp) of securities with a financial institution.  

## Advantages and Disadvantages of TIPS

### Pros of TIPS

The benefits include the following:

*   **Inflation protection**: By this point, it should be obvious that TIPS are specifically structured to safeguard investors against inflation. The principal amount of TIPS is adjusted based on changes in the CPI. 
*   **Safety and stability**: One of the most compelling advantages of TIPS is their safety and stability. TIPS are issued and backed by the U.S. government, meaning they (usually) can be considered lower risk of default.
*   **Regular interest payments**: For investors wanting some cash flow, TIPS provide semiannual interest payments. This feature can be quite important, especially to retirees or those needing a steady and potentially increasing income. 
*   **Capital appreciation potential**: Meanwhile, TIPS can also rise in value. As inflation rises, the principal value of TIPS is adjusted upward. If you sell your TIPS before maturity, they may realize capital gains, especially when inflation is running high. 
*   **Tax advantages**: TIPS offer tax benefits, particularly for investors in high-tax states. While the interest income from TIPS is subject to federal income tax, it's exempt from state and local taxes. 
*   **Diversification**: Though the correlation among investments is always shifting, TIPS can perform differently from other asset classes that may act negatively toward rising prices and inflation. 
*   **Market liquidity**: Last, TIPS are highly [liquid](https://www.investopedia.com/terms/l/liquidity.asp) securities, that is, they can be bought and sold with relative ease in the secondary market.

### Disadvantages of TIPS

Along with those advantages, there are some disadvantages to consider. 

*   **Lower yield than other bonds**: TIPS typically offer lower yields than other bonds. This is because they tend to carry less risk (because the government issues them).
*   **Inflation adjustment taxation**: One significant disadvantage of TIPS is the taxation of inflation adjustments. While the principal value of TIPS increases with inflation, this increase is considered taxable income in the year it occurs, even though you won't receive this amount until the security matures or is sold. This means taxpayers would have to pay tax on something they haven’t received the cash for (yet). 
*   **Deflation risk**: Although TIPS protect against inflation, they are less beneficial during [deflationary periods](https://www.investopedia.com/terms/d/deflation.asp). If the CPI decreases, the principal value of TIPS is adjusted downward. This reduces the overall return on the investment as the overall value of the security decreases.
*   **Liquidity issues in times of crisis**: We mentioned that liquidity was an advantage. However, during financial crises or periods of market stress, when lots of people are trying to cash-out at the same time, it may be difficult to sell (or at least sell for the price you want to).  
*   [**Opportunity costs**](https://www.investopedia.com/terms/o/opportunitycost.asp): TIPS are generally used to [hedge](https://www.investopedia.com/terms/h/hedge.asp) against risk rather than act as a booming investment prospect.  
    

Pros

*   The principal increases with inflation, meaning that at maturity, bondholders are paid the inflation-adjusted principal.
    
*   Investors will never be paid less than their original principal when TIPS mature.
    
*   Interest payments increase as inflation increases, since the rate is calculated based on the adjusted principal balance.
    

Cons

*   The interest rate offered is usually lower than most fixed-income bonds that do not have an inflation adjustment.
    
*   Investors might be subject to higher taxes on increased coupon payments.
    
*   If there isn't much inflation while the TIPS are held, then they won't be as useful.
    

## Best Type of Investor for TIPS

Not everyone needs the inflation protection that TIPS offer. However, certain types of investors may find these government-backed securities particularly valuable for their portfolios.

**Retirees and near-retirees** often benefit most from TIPS. Living on a fixed income makes them especially vulnerable to inflation's effects on their purchasing power. TIPS's automatic inflation adjustments can help ensure their retirement savings maintain value over time. For example, if inflation pushes grocery prices up 5%, TIPS payments would increase to help offset those higher costs.

**Conservative investors** who prioritize protecting their principal over maximizing returns are another natural fit for TIPS. Since the U.S. government backs them, TIPS carry minimal default risk. This safety makes them popular with institutional investors like pension funds and insurance companies, who need reliable ways to match their future payment obligations with inflation-protected assets.

**Long-term investors** worried about inflation's impact over many years may also want to consider TIPS. However, these securities work best as part of a broader investment strategy rather than a short-term inflation hedge.

**Tax-sensitive investors in high-tax states** get an additional benefit. While TIPS interest is subject to federal taxes, it's free from state and local taxes. However, investors should note that they'll owe federal taxes on the inflation adjustments to principal each year, even though they won't receive that money until the TIPS mature.

## TIPS and Nominal Bonds

Let's quickly cover the difference between [nominal](https://www.investopedia.com/terms/n/nominalvalue.asp) bonds and TIPS. Nominal bonds and TIPS are both types of bonds issued by the U.S. Treasury, but they differ primarily in how they handle inflation protection. Nominal bonds, also known as conventional bonds, pay a fixed interest rate over the life of the bond, and the principal value remains constant until maturity.

Here's what makes them different:

*   Regular Treasury bonds pay the same interest amount every six months, based on their original principal. If you buy a $1,000 bond paying 3%, you'll get $15 every six months, period.
*   TIPS adjust both their principal and interest payments based on inflation. That same $1,000 investment might grow to $1,020 if inflation is 2%, meaning your interest payments would grow too.

## Have Have TIPS Performed?

In the early 2020s, inflation in the U.S. hit highs not seen in four decades, leading many investors to flock to TIPS for protection. However, that insurance policy didn’t really go according to plan. These inflation-protecting securities fell an average of 14.2% in 2022, performing not much better than regular Treasurys and major equity markets.

To get a sense of how TIPS have done recently, we can look at the stats for the iShares TIPS Bond ETF ([TIP](https://www.investopedia.com/markets/quote?tvwidgetsymbol=tip)):

## How TIPS Perform Relative to the Stock Market

We should explain the metric "[beta](https://www.investopedia.com/terms/b/beta.asp)" in the above table for the TIP ETF. The relatively low beta—much less than 1.0—means it's far less volatile than the overall stock market. For instance, when the beta is 0.26, that means if the stock market jumps in one direction, 10%, TIP would only move about 2.6%.

This low beta makes sense since TIPS are government bonds designed for stability and inflation protection rather than aggressive growth.

## How Can I Buy Treasury Inflation-Protected Securities (TIPS)?

You can buy TIPS directly from the U.S. Treasury’s TreasuryDirect website, with a minimum purchase of $100. You can also typically buy them through your broker. Several mutual funds and [ETFs invest in TIPS](https://www.investopedia.com/articles/investing/092215/top-5-tips-etfs.asp) and other inflation-linked securities that you can buy and sell like ordinary shares of stock.

## Can I Buy TIPS for My Individual Retirement Account (IRA)?

Yes. You can include TIPS and funds that hold TIPS in an [individual retirement account (IRA)](https://www.investopedia.com/terms/i/ira.asp); however, you cannot use the TreasuryDirect service to buy them directly in an IRA. Instead, you would need to rely on the broker holding your retirement account.

## What Yields Do TIPS Have?

The yields on TIPS are often _negative._ This is because after taking into account the effects of inflation, the [real yield](https://www.investopedia.com/terms/r/realinterestrate.asp) is negative. For instance, if standard two-year Treasurys yield 1% but inflation is 2%, then the real yield is -1%.

TIPS are meant to keep up with inflation, not beat inflation. Therefore, you can have a [nominal yield](https://www.investopedia.com/terms/n/nominalyield.asp) on TIPS that is positive but a real yield that is effectively zero. Note that while the yield on TIPS may be negative, their principal value will increase with inflation, which can generate [capital gains](https://www.investopedia.com/terms/c/capitalgain.asp).

## Why Does the Treasury Issue TIPS?

TIPS first appeared in 1997. The official reason for their appearance is that there was strong [demand](https://www.investopedia.com/terms/d/demand.asp) from the investing public for inflation-linked government securities. However, some economists have been puzzled by the government’s continued issuance of TIPS since they amount to a more expensive way to borrow than traditional Treasurys.

## What Maturities Do TIPS Come in?

The original TIPS were set at 20-year maturities. In 2009, 20-year TIPS were discontinued in favor of 30-year TIPS. The U.S. Treasury currently issues five-, 10-, and 30-year TIPS.

## The Bottom Line

TIPS are among the many types of debt securities offered by the U.S. Treasury Department. You can think of them as Treasurys with a twist—their principal value is tied to inflation to protect investors when the cost of living rises.

It’s important to know that inflation protection comes at a cost, as most of these securities carry lower interest rates than other similar government bonds. Also, bear in mind that at the time of maturity, bondholders are paid the inflation-adjusted principal or original principal, whichever is greater.  

> **Article Sources**
>
> 1.  TreasuryDirect. "[History of Treasury Inflation-Protected Securities (TIPS)](https://www.treasurydirect.gov/research-center/history-of-marketable-securities/tips/)."
> 2.  TreasuryDirect. “[Treasury Inflation Protected Securities (TIPS)](https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm).”
>     
> 3.  Lark Research. “[2022 Returns on TIPS](https://larkresearch.com/treasury-inflation-protected-securities-tips/2022-returns-on-tips/).”
>     
> 4.  TreasuryDirect, via Internet Archive. “[History of Treasury Inflation-Protected Securities (TIPS)](https://web.archive.org/web/20220513195515/https://www.treasurydirect.gov/indiv/research/history/histmkt/histmkt_tips.htm).”
>     
> 5.  Matthias Fleckenstein, Francis A. Longstaff, and Hanno Lustig, via University of California, Los Angeles, Anderson School of Management. “[The TIPS-Treasury Bond Puzzle](https://www.anderson.ucla.edu/sites/default/files/documents/areas/fac/finance/longstaff%20TIPS.pdf).” _The Journal of Finance_, vol. 69, no. 5, 2014, pp. 2151–2197.