Loading the player...

What are 'Treasury Inflation Protected Securities - TIPS'

Treasury inflation protected securities (TIPS) refer to a treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and because the par value rises with inflation, as measured by the Consumer Price Index, while the interest rate remains fixed.

BREAKING DOWN 'Treasury Inflation Protected Securities - TIPS'

Interest on TIPS is paid semiannually. TIPS can be purchased directly from the government through the TreasuryDirect system, in $100 increments with a minimum investment of $100, and are available with 5-, 10-, and 30-year maturities.

Because the semiannual inflation adjustments of a TIPS bond are considered taxable income by the IRS, even though investors don't see that money until they sell the bond or it reaches maturity, some investors prefer to get TIPS through a TIPS mutual fund or exchange traded fund (ETF), or to only hold them in tax-deferred retirement accounts to avoid tax complications. Purchasing TIPS directly, however, allows investors to avoid the management fees associated with mutual funds. TIPS are also valuable because they are exempt from state and local income taxes.

Example of Treasury Inflation Protected Securities Adjustments

Suppose an investor owns $1,000 in TIPS at the end of the year, with a coupon rate of 1%. If there is no inflation as measured by the CPI, the investor will receive $10 over the year in coupon payments. If inflation rises by 2%, however, the $1,000 principal will be adjusted upward by 2% to $1,020. The coupon rate will still be the same at 1% but it will be multiplied by the new principal amount of $1,020 to get an interest payment of $10.20. On the other hand, if inflation was negative, as in deflation, with prices as measured by the CPI falling 5%, the principal would be adjusted downward to $950. The resulting interest payment would be $9.50 over the year.

At maturity, the investor would receive the principal equal to either the original principal of $1,000 or an adjusted higher principal, if applicable. The interest payments during the life of the bond are subject to being calculated from a lower principal, but the investor is never at risk of losing the total principal of TIPS if held to maturity. The investor can sell TIPS for less than the initial principal in the secondary market, however, before maturity.

Risks of Treasury Inflation Protected Securities

TIPS usually carry interest rates lower than other government or corporate securities, so they are not necessarily optimal for income investors. Their advantage is mainly inflation protection, but if inflation is minimal or nonexistent, their utility decreases. Another risk associated with TIPS is a higher tax bill. The adjustments of principal are considered income for tax purposes, although investors do not receive the adjustments, but instead receive the coupons that result from them. Thus, investors may be subject to tax on "phantom income," with the gain in principal outweighing the coupons received.

RELATED TERMS
  1. Inflation Protected

    The types of investments that provide protection against inflation ...
  2. Principal

    1. The amount borrowed or the amount still owed on a loan, separate ...
  3. Form 4070: Employee's Report Of ...

    A tax form distributed by the Internal Revenue Service (IRS) ...
  4. Inflation Swap

    A derivative used to transfer inflation risk from one party to ...
  5. Coupon Rate

    The yield paid by a fixed income security. A fixed income security's ...
  6. IRS Publication 1244: Employee's ...

    A document published by the Internal Revenue Service (IRS) that ...
Related Articles
  1. Investing

    Using the TIPS Spread to Predict Inflation (TIP, ATPIX)

    Learn how analysts and investors use the TIPS spread to forecast inflation rates, and how accurate the TIPS spread has been as an inflation predictor.
  2. Investing

    Why Some Investors Are Tilting Toward TIPS

    Last month’s five-year TIPS auction drew nearly $48 billion in interest, a sign of recent renewed demand for this inflation indexed asset among investors.
  3. Financial Advisor

    Are TIPS a Good Buy Right Now?

    TIPS are trading at a big discount making this a good time to get into these instruments for those who believe that inflation is on the horizon.
  4. Investing

    2 Popular Inflation Protected "TIPS" Bond ETFs in 2016 (TIP, IPE)

    Learn about how Treasury Inflation Protected Securities (TIPS) work, and discover two of the more popular ETFs that invest in TIPS.
  5. Investing

    Treasury Inflation-Protected Securities (TIPS)

    Treasury inflation-protected securities are treasury securities that make adjustments for inflation as reflected in the Consumer Price Index.
  6. Investing

    Introduction To Treasury Inflation-Protected Securities (TIPS)

    If you want to protect your portfolio from inflation, all you need are a few TIPS.
  7. Financial Advisor

    3 Reasons to Stay Away From TIPS

    Learn three reasons why you should avoid investing in Treasury inflation-protected securities (TIPS) and why bondholders are better off with other vehicles.
  8. Investing

    Shield Your Portfolio From Inflation For Real Returns

    Inflation-protected securities are part of the equation, but they're not a perfect solution.
  9. Investing

    The 4 Best Inflation-Protected Funds To Invest In (SCHP)

    Discover how Treasury inflation-protected securities (TIPS) work, and learn about five funds in this segment that make good investments.
  10. Investing

    TIPS are Hot: Is Inflation Back?

    As of Friday, there are indications that inflation is at last picking up. Treasury inflation-protected securities (TIPS) are attracting more attention from investors, indicating that the market ...
RELATED FAQS
  1. How do I calculate yield of an inflation adjusted bond?

    Learn how to calculate the real yield of an inflation-adjusted bond, such as the U.S. Treasury inflation-protected security ... Read Answer >>
  2. What is inflation and how should it affect my investing?

    Inflation, an economic concept, is an economy-wide sustained trend of increasing prices from one year to the next. The rate ... Read Answer >>
  3. How does inflation affect fixed-income investments?

    Learn about the ways inflation can harm fixed-income investments. Find out how to monitor the impact of inflation using common ... Read Answer >>
  4. In the context of a bond, what does the principal refer to?

    Get introduced to the world of bond investing and learn what the term "principal" means in reference to a corporate or government ... Read Answer >>
  5. What is the difference between a bond's yield rate and its coupon rate?

    Learn why bond coupon payments, which are a series of fixed payments made to a bondholder throughout the life of the bond, ... Read Answer >>
Hot Definitions
  1. Leverage

    1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. ...
  2. Trumponomics

    Trumponomics is a term for the economic policies of President Donald Trump.
  3. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  4. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
  5. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  6. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
Trading Center