Treasury Inflation-Protected Securities (TIPS) and Inflation

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Treasury Inflation-Protected Securities (TIPS) and Inflation

Treasury inflation-protected securities, or TIPS, have been called the only asset class that’s truly risk-free. The securities are backed by the full faith and credit of the U.S. government, so there’s no credit risk. In addition, TIPS’ principal values adjust to keep pace with inflation, which helps protect owners’ purchasing power. That’s a benefit holders of nominal Treasury bonds do not have. Assuming real yields are positive—and that hasn’t always been the case—someone buying and holding a TIPS bond to maturity is guaranteed a positive real return.

How the inflation protection works

TIPS bonds pay interest twice a year. In addition, TIPS bonds’ principal values regularly adjust to reflect changes in the Consumer Price Index, both up or down. The net effect of that adjustment is that if inflation goes up, so do TIPS’ principal values and in turn their yields. When inflation is falling, TIPS’ principals are adjusted downward, taking yields down in the process. When a TIPS bond matures, the owner receives either the bond’s original value or the value adjusted upward for inflation, whichever is greater.