What Is a Treasury Inflation-Protected Security?

Introduction

Inflation slowly eats away at the value of money. If prices rise 4% in a year, your savings buy less than before. Treasury Inflation-Protected Securities, or TIPS, are a type of government bond designed to protect investors from inflation.

What Are TIPS?

TIPS are bonds issued by the U.S. Treasury. Like other Treasury bonds, they are backed by the U.S. government. What makes them special is that their principal, or face value, adjusts with inflation, based on the Consumer Price Index.

How They Work

If you own a $1,000 TIPS bond and inflation is 3% that year, the principal rises to $1,030. The bond pays a fixed interest rate on the adjusted principal, so your interest payments also rise with inflation. When the bond matures, you receive either the adjusted principal or the original amount, whichever is higher.

Things to Know

TIPS usually pay lower interest rates than regular Treasury bonds, because investors are paying for inflation protection. If inflation turns out lower than expected, regular bonds may perform better. The inflation adjustments are also taxable each year, even though you do not receive that money until maturity, so many investors hold TIPS in retirement accounts.

Conclusion

TIPS are a smart way to protect part of your savings from inflation. They show how creative financial tools can help investors deal with rising prices!