Worried About Inflation? Consider TIPS

Key Points

  • Treasury Inflation-Protected Securities can help protect portfolios from rising inflation.

  • The cost of inflation protection is relatively low today.

  • TIPS yields are negative, so keep total return expectation in check.

Worried about inflation? Treasury Inflation-Protected Securities, or TIPS, can help protect your portfolio against rising inflation.

When building a diversified portfolio, positive total returns aren’t the only thing to consider—making sure your investments keep pace with inflation is important as well. Because the principal value of TIPS rise and falls with the level of inflation, they can help your portfolio keep pace with inflation.

Before investing in TIPS, there are some important nuances to be aware of today, like negative yields and the cost of inflation protection.

TIPS—the basics

TIPS are a type of Treasury security whose principal value is indexed to inflation. As the level of the Consumer Price Index (CPI) rises and falls, so too does the value of a TIPS. Like traditional Treasury securities, TIPS have fixed coupon rates based off of the principal value—so coupon payments also rise or fall with the level of the CPI as the principal value fluctuates.

This characteristic helps TIPS protect investors against the effects of inflation, because they’ll be rewarded with a higher principal value at maturity as well as growing coupon payments if inflation is rising. (Traditional Treasuries simply mature at their $1,000 par value.) The opposite is true as well: In deflationary periods, the principal value of a TIPS will fall, resulting in smaller coupon payments. At maturity, however, a TIPS investor would receive either the adjusted principal or the original principal value. In other words, TIPS never pay back less than the initial principal value at maturity.