2025 Guide: Treasury Inflation-Protected Securities (TIPS) Prices and Benefits Explained

With over 20 years of experience, Gordon Scott is a seasoned investor and Chartered Market Technician (CMT), specializing in technical analysis.

What Are Treasury Inflation-Protected Securities (TIPS)?

TIPS are a special category of U.S. Treasury bonds designed to protect investors from inflation by linking the bond’s principal to an inflation index, typically the Consumer Price Index (CPI). As inflation rises, so does the principal value of these bonds, ensuring your investment maintains its purchasing power.

Key Highlights

• TIPS adjust the principal value based on inflation changes to safeguard against loss of purchasing power.
• Interest payments are calculated on the inflation-adjusted principal, potentially increasing your income during inflationary periods.
• At maturity, investors receive at least their original principal, guaranteeing protection against deflation.

How TIPS Work

The principal of TIPS increases with inflation as measured by the CPI, ensuring your investment grows in line with rising prices. If inflation rises, your interest payments rise because they are based on the adjusted principal. Conversely, in deflationary periods, the principal value may decrease, lowering interest payments, but you will never receive less than your original investment at maturity.

TIPS are issued with maturities of 5, 10, and 30 years and are considered a low-risk investment since they are backed by the U.S. government.

Purchasing TIPS

You can buy TIPS directly from the U.S. Treasury through TreasuryDirect.gov starting at $100 increments or invest via mutual funds or ETFs that focus on TIPS. Direct purchases avoid management fees, while funds provide diversification and ease of access.

Relationship Between TIPS and Inflation

TIPS are crucial for investors worried about inflation risk, which can erode returns on fixed-rate bonds. Unlike nominal bonds that pay fixed interest irrespective of inflation, TIPS adjust principal and interest payments in response to inflation, preserving real value.

For example, with $1,000 invested in TIPS at a 1% coupon, zero inflation results in $10 interest. If inflation hits 2%, the principal adjusts to $1,020 and interest rises to $10.20. If deflation of 5% occurs, principal adjusts down to $950 and interest to $9.50, but the original $1,000 is protected at maturity.

Important Note

TIPS are designed as a long-term inflation hedge, not for short-term inflation spikes.

Advantages of Investing in TIPS

• Inflation Protection: Principal and interest payments adjust with inflation.
• Safety: Backed by the U.S. government, offering low default risk.
• Stable Income: Semiannual interest payments that can increase with inflation.
• Capital Growth Potential: Principal value appreciation during inflationary periods.
• Tax Benefits: Exempt from state and local taxes on interest income.
• Diversification: Adds inflation-hedged assets to your portfolio.
• Liquidity: Easily tradable in the secondary market.

Drawbacks of TIPS

• Lower Yields: Typically offer lower yields than other bonds.
• Taxation on Inflation Adjustments: Inflation increases are taxable as income annually, even if not received until maturity.
• Deflation Exposure: Principal can decrease during deflation, reducing interim returns.
• Liquidity Challenges During Crises: May be harder to sell during market turmoil.
• Opportunity Cost: Potentially lower returns compared to higher-risk investments.

Who Should Invest in TIPS?

TIPS are ideal for conservative investors focused on capital preservation who want inflation protection backed by the U.S. government. Retirees benefit from steady, inflation-adjusted income. Institutional investors like pension funds use TIPS to match liabilities with inflation-protected assets. Investors seeking tax advantages in high-tax states and those looking for portfolio diversification will also find TIPS appealing.

TIPS vs. Nominal Bonds

While both are U.S. Treasury securities, nominal bonds pay fixed interest with no inflation protection, and principal remains constant. TIPS adjust principal and interest with inflation. Both are subject to federal tax, but only TIPS’ inflation adjustments are taxed annually.

Example: 10-Year TIPS vs. 10-Year Treasury Note

In March 2019, the 10-year TIPS auctioned at 0.875% interest. By March 2024, real yields increased to 1.932%, reflecting inflation expectations. This highlights how TIPS yields can change with inflation forecasts.

Performance Overview

During the 2022 inflation surge, TIPS fell 14.2% alongside broader bond market declines due to rising interest rates. In 2023, as inflation cooled, TIPS returned approximately 1%, but some gains were lost early in 2024. This illustrates that TIPS, while inflation-protected, are still subject to market risks.

How to Purchase TIPS

Buy TIPS directly via TreasuryDirect.gov with a minimum $100 investment or through brokers and ETFs. They are also available in IRAs via brokerage accounts, but not directly through TreasuryDirect for retirement accounts.

Understanding TIPS Yields

TIPS yields can be negative in real terms when inflation outpaces nominal yields. Their goal is to preserve purchasing power rather than generate high returns. Capital gains may occur as principal adjusts upward with inflation.

Why the Treasury Issues TIPS

Introduced in 1997 due to investor demand for inflation-protected assets, TIPS provide a government-backed option to hedge inflation, although they typically cost more to issue than nominal Treasuries.

Available Maturities

Currently, TIPS are issued with 5-, 10-, and 30-year maturities, having replaced the original 20-year bonds in 2009.

Conclusion

TIPS offer a unique way to safeguard your investments against inflation with government backing and inflation-adjusted principal and interest. While they come with lower yields and tax considerations, their inflation protection and capital preservation features make them valuable for long-term, conservative investors. Remember, TIPS are not a perfect short-term hedge but a strategic tool for managing inflation risk over time.

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