What Are Treasury Inflation-Protected Securities (TIPS)?
TIPS shield investors from inflation by adjusting the principal every six months. Here’s how they work and what you should consider.
Sean Canonica
Senior Finance Writer
Sean is a finance writer and content strategist for ComparisonAdviser. He has over three years of experience writing about various topics, such as insurance, financial advisors, and investing. Additionally, he is a co-founder and the CEO of RateSonic, an online insurance resource. Sean values helping readers understand difficult topics by creating easy-to-read and thorough content.
View ProfileWhile it’s important to pad your savings, inflation can cut into your spending power as time moves along. For this reason, it’s key for investors to choose securities that safeguard their cash from rising costs. Treasury Inflation-Protected Securities (TIPS) are fixed-income securities that index for inflation to help you avoid any impact as much as possible.
In this article, we’ll explain how TIPS work and why they’re important. You’ll also learn the benefits and disadvantages of including them in your portfolio. Finally, we’ll break down who typically invests in these securities and how to do so.
Key Takeaways
- TIPS are a type of note issued by the U.S. government via TreasuryDirect, brokerage firms, or banks.
- Term limits for TIPS are available for five, 10, or 30 years.
- You’ll receive semiannual interest payments based on a principal amount, which readjusts for inflation every six months.
- While TIPS can shield you from inflation, they often yield smaller returns than other bonds.
How TIPS Work
TIPS are a type of marketable security offered by the U.S. government. They exist to keep up with inflation, or the rising costs of goods and services tracked by the Consumer Price Index (CPI), by paying out principal and adjusted interest to account for it. Additionally, they have the full faith and credit of the government backing them, making them less risky than other fixed-income securities. Typically, the U.S. sells them as notes in $100 increments for five, 10, or 30 years.
When you buy TIPS, you’ll receive semiannual interest payments. These are made according to a principal amount, or face value, that adjusts for inflation reflected by the CPI. For example, if inflation rises, the bond’s principal amount will increase. Similarly, if the CPI decreases, so too will the principal. This allows one to curb inflation while staying invested in fixed-income securities.
As an example, consider that you bought $1,000 worth of TIPS over a term of 10 years. If inflation were to rise by 2%, the value of the TIPS in your portfolio would increase to $1,020. On the flip side, if the CPI experienced a deflation of 2%, the principal would drop to $980.
In both instances, there is a readjustment to account for the change in costs of goods and services. Once your TIPS mature, you’ll receive the higher of the inflation-adjusted principal or the original principal.
TIPS vs. I Bonds
Series I savings bonds, or I-bonds, are another type of fixed-income security that can help safeguard against rising costs. They earn monthly interest, with the rate changing every six months to keep up with inflation. The interest rate is split into two parts, one that’s fixed and the other for inflation. Here, only the latter changes.
While both TIPS and I-bonds adjust for inflation, there are key differences to note between the two. First, you may sell TIPS on the market, allowing more flexibility than an I-bond. You also have more options, with the former allowing you to pick between five, 10, or 30-year terms rather than only 30 for I-bonds. Finally, I-bonds only let you buy up to $15,000 annually, whereas TIPS enable you to purchase up to $10,000,000 at auction or an infinite amount secondhand.
| Treasury Inflation-Protected Securities (TIPS) | Series I Savings Bonds (I-Bonds) |
|---|---|
| Allows you to buy an unlimited amount on the secondary market and up to $10,000,000 at auction. | Only able to buy up to $15,000 worth per Social Security number. |
| Term limits are available for five, 10, or 30 years. | Term limits must be 30 years. |
| Ability to sell on the secondary market. | May not be sold on the secondary market. |
| Can be bought either via TreasuryDirect or from broker-dealers and banks. | Must be purchased online with TreasuryDirect or on paper via your tax refund. |
Pros and Cons of TIPS
TIPS can be an effective tool to keep up with inflation, especially in the long term. This is because they adjust for inflation and, if you want, you can lock them in for up to 30 years. They can also be resold at any time on the secondary market, allowing you additional flexibility. And, because they’re backed by the government and will pay you your original principal by the maturity date, there’s a low risk associated with investing in them.
While TIPS may be beneficial for many, there are some crucial disadvantages to consider. For instance, they generally yield less than corporate or other types of government bonds due to a smaller interest rate. Additionally, as the U.S. federal funds rate increases, the market price of bonds can decrease.
Below is a breakdown of the pros and cons to think about before investing in TIPS:
Pros
- Readjustments help safeguard against inflation.
- Term limits of 5, 10, or 30 years.
- Ability to resell on the secondary market, allowing for more flexibility.
- Less risk because they’re backed by the full faith and credit of the U.S. government.
Cons
- Changing interest rates can decrease the market value of TIPS.
- Returns can be less than other fixed-income securities, such as corporate bonds.
- Whenever an adjustment for inflation occurs, the change to the principal could be subject to federal income tax in the same year.
How to Invest In TIPS
Both individuals and institutional investors may purchase TIPS. Currently, you can do so via a brokerage firm, bank, or via TreasuryDirect. Moreover, you can add them to your taxable brokerage account or tax-advantaged savings accounts, such as traditional or Roth IRA.
TIPS may be beneficial, but we recommend speaking to a financial advisor before buying any. A professional can help determine whether investing in these securities makes sense for your goals, risk tolerance, and time horizon. If you need help finding an advisor near you, consider this free matching tool, which will connect you with a vetted expert that aligns with your needs.
Frequently Asked Questions
Are TIPS a good investment?
TIPS may be a wise investment if you’re looking to hedge against inflation. And, because you can purchase notes for up to 30 years, they can be an effective long-term option. However, they also provide modest returns, which presents an opportunity cost. We recommend consulting with a financial advisor before adding them to your portfolio to ensure that they’re the best option for you.
What are the term limits for TIPS?
TIPS have term limits of five, 10, or 30 years. After the maturity period, you’ll receive either the original or inflation-adjusted principal, whichever amount is higher. Also, be aware that the face value adjusts for inflation every six months.
When should you invest in TIPS?
In general, you should consider investing in TIPS if you’re looking to protect yourself against inflation for a set period. You might also utilize them to diversify your portfolio while shielding your funds from rising costs.
Is there any risk of investing in TIPS?
TIPS carry a low risk because they’re backed by the full faith and credit of the U.S. and guarantee that you’ll at least receive your original principal once the note matures. There is, however, an interest rate risk to be aware of. If the federal funds rate decreases, so will the market value of fixed-income securities. This could impact your strategy if you intend to resell your notes.