Takeaways
- TIPS help protect investors' portfolios from inflation.
- TIPS have a principal value that can increase or decrease based on the CPI.
- TIPS come with a fixed interest rate and, unusually, have three maturity levels.
- TIPS can be purchased through online brokers or directly from the U.S. Treasury.
- TIPS are an essential part of a well-balanced and diversified investment portfolio.
Investments don’t take a day off, and many of those days will have volatility. Investing or holding investments in a volatile market requires a solid understanding of the financial instruments you’re leveraging. One of the lesser-known but one of the most powerful instruments in turbulent markets is Treasury Inflation-Protected Securities (TIPS).
TIPS are designed to help hedge your investments against inflation. Here, we will explore the information you need about TIPS, including how they work and where to get them. Not all investments are created equal, so we will dig into their pros and cons for you to have both sides of the story.
Take the Next Step:
Quicken’s Website
Axos Bank® Rewards Checking
Smart Money Rating: 5/5
APY: 3.30% with No Minimum Balance
Bonus Offer: Up to $500 Bonus (Terms Apply)
What Are Treasury Inflation Protected Securities (TIPS)?
Treasury Inflation-Protected Securities, or TIPS, are marketable U.S. Treasury securities designed to protect your purchasing power. They are issued by the U.S. Department of the Treasury, with their principal value rising in correlation with inflation and falling with deflation, ensuring that the purchasing value of your investment remains stable over time. They are available in 5-year, 10-year, and 30-year maturities, and you can invest in them for as little as $100 (in increments of $100).[1]
Read More: How Does the Federal Reserve Control Interest Rates?
TIPS and Inflation
The biggest draw of a TIPS is its ability to protect your investments from the eroding purchasing power effects of inflation. Unlike most conventional treasury securities, the principal value of TIPS is adjusted twice a year based on changes in the Consumer Price Index for All Urban Consumers (CPI-U), one of the most popular gauges of inflation. Here is how they work.
First, if inflation occurs (i.e., there’s a rise in CPI-U), the principal value of your TIPS grows (that’s a good thing). Conversely, if there is deflationary activity, the principal value decreases. Your principal is pegged to the ebb and flow of the CPI, allowing you to sleep easy at night because your purchasing power is not gradually dissipating.
Second, a TIPS has a fixed interest rate. However, the amount of interest you receive every six months is calculated based on the adjusted principal. As a result, during inflation, your interest payments will be higher due to the higher principal balance, but when that principal falls during deflation, so do your interest payments.
Because of these unique mechanisms, Treasury Inflation-Protected Securities can provide a relatively reliable way to maintain the purchasing power of your investments during economic cycles of booms and busts. This is why Treasury Inflation-Protected Securities are a valuable part of a diversified investment portfolio, particularly during inflationary times.
How to Buy TIPS
Buying TIPS is straightforward and can be done in a few different ways. That said, Treasury Inflation-Protected Securities are only available in electronic form now. Here are three of the most common ways that you can add TIPS to your investment portfolio:
- Treasury Direct: You can buy TIPS directly from the U.S. Department of the Treasury through their online platform, TreasuryDirect.gov. Treasury Direct is a secure and direct method to purchase and hold TIPS at no cost.
- Brokerages: Various brokerages also offer TIPS for purchase. You can buy them through a broker, though depending on the broker’s pricing structure, you might incur some fees.
- Banks: Some banks offer you the ability to purchase TIPS, but not all banks offer the service. Contact your bank to see if they offer this and ask about any associated fees so you can go into it fully informed.
Our Picks: Best Online Stock Brokerage Accounts
Take the Next Step:
Acorns Website
Acorns Investing App
Smart Money Rating: 5/5
Intro Offer: $20 Bonus Investment
Best For: Beginner Investors
Annual Fee: N/A
Advantages and Disadvantages of TIPS
Treasury Inflation-Protected Securities have their rightful place in any investment portfolio. However, there are certainly advantages and disadvantages to adding TIPs to your investment asset allocation. Knowing the pros and cons will allow you to make the best capital allocation decision to maximize their benefits for your portfolio.
Advantages of TIPS
- Inflation Protection: Your principal increases with inflation and decreases with deflation, not your interest rate, preserving the real value of your investment. Because of this, the purchasing power of your investment remains stable over time, which is particularly beneficial during periods of rising inflation.
- Safe investment: TIPS are backed by the U.S. government, making them a low-risk investment. This assurance of safety provides peace of mind, as the likelihood of default is extremely low compared to other investment vehicles.
- Reliable Interest Income: You receive interest payments every six months, providing a steady income stream. These regular payments can be a reliable source of income, which can be especially appealing if you are looking for a stable, low-risk investment.
- Liquidity: Just like you can buy TIPS from different sources, you can buy and sell (importantly) in secondary markets. As a result, TIPS are highly liquid, which means you can easily buy a TIP or sell your TIP if you need to adjust your investment strategy. Of course, this can result in an investment gain or loss, depending on your position.
Read More: 9 Ways to Create Passive Income
Take the Next Step:
Member FDIC
Quontic High Yield Savings Account
Smart Money Rating: 5/5
APY: 4.50%
Required Minimum Balance: $100
Disadvantages of TIPS
- Relatively Low Yeild: TIPS usually offer lower yields than other types of treasury securities. For example, as of February 2025, the yield on a 5-year TIP was 1.66%, and the yield on some dividend-paying stocks is well above 7%.
- Tax Implications: While earnings from TIPS are tax-exempt on a state and local level, they are taxed at the federal level. TIPS owners pay federal income tax on the interest income in the year it is received and on growth in principal in the year it occurs. If you own Treasury Inflation-Protected Securities, you must file.[2]
- 1099-INT: To show the interest paid on the security during the tax year.
- 1099-OID: To show an increase or decrease in principal value during the tax year.
Note: Consult a tax professional for advice on filing taxes.
- Deflationary Value Loss: In a deflationary environment, the principal of TIPS decreases, which may result in a lower final payout upon maturity.
Read More: What You Need to Know About Form-1099s
Example of a TIP
Suppose you invest $1,000 in a TIPS with a 1% fixed interest rate and a 10-year maturity. If inflation rises by 2% in the first year, your principal adjusts to $1,020. Consequently, the interest payment you receive will be calculated on this new principal amount, resulting in an interest payment of $10.20 instead of $10.
Over the term of your Treasury Inflation-Protected Security, if inflation keeps rising, your principal and interest payments will increase correspondingly, preserving the real value of your investment. On the other hand, if deflation occurs, your principal and interest payments would decrease, demonstrating how TIPS provides a hedge against inflation while carrying a risk in deflationary scenarios.
Common Tip Maturities
There are three tranches of TIPS maturities, each with upsides and downsides and a potential place in your investment horizon. There are TIPS available in 5, 10, and 30 years. A 5-year TIPS might be best if you have a shorter-term goal or prefer less exposure to interest rate risk. A 10-year TIPS offers a comfortable middle ground, balancing duration with yield. Finally, a 30-year TIPS provides the longest term, often with a higher yield, but increased exposure to interest rate risk due to the substantial term length.
For a Diversified Portfolio, you might also like:
Smart Summary
Finding investments that fit with your long-term financial goals is essential for creating an investment portfolio that gets you where you want to go. Whether that is to early retirement, building passive income streams, or focusing on traditional retirement, learning about different types of investments like stocks, bonds, and Treasury Inflation-Protected Securities is a smart money move. Maximize your money’s value through smart investment decisions today.
(1) Treasury Direct. Treasury Inflation-Protected Securities. Last Accessed January 27, 2025.
(2) Treasury Direct. Treasury Inflation-Protected Securities Forms. Last Accessed January 27, 2025.
