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. TIPS Spread

    TIPS spread compares the yield of the Treasury Inflation Protection ...
  2. Inflation Protected

    The types of investments that provide protection against inflation ...
  3. Form 4070: Employee's Report Of ...

    A tax form distributed by the Internal Revenue Service (IRS) ...
  4. IRS Publication 531

    A document published by the Internal Revenue Service (IRS) that ...
  5. Dual Currency Issue

    A bond that pays interest in one currency but pays the principal ...
  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

    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.
  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

    Treasury Inflation-Protected Securities (TIPS)

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

    Introduction to Treasury Inflation-Protected Securities (TIPS)

    If you want to protect your portfolio from inflation, all you need are a few TIPS.
  6. 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.
  7. Financial Advisor

    Why the TIPS Rally Might Not Be Real

    The influx of money into TIPS that ended in April is probably not an indicator that real inflation is on the horizon.
  8. Financial Advisor

    Top 5 TIPS ETFs

    Learn about exchange-traded funds that invest in U.S. Treasury inflation-protected securities of different durations and yields to maturity.
  9. Investing

    Shield Your Portfolio From Inflation For Real Returns

    Inflation-protected securities are part of the equation, but they're not a perfect solution.
  10. 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.
RELATED FAQS
  1. It is now 6 month after you just purchased a $1,000 face value TIPS ...

    The correct answer is d. TIPS are a special type of Treasury note or bond that offers protection from inflation. When you ... Read Answer >>
  2. What are the responsibilities of the principal in a company?

    Learn to differentiate between some of the many definitions and responsibilities of a "principal" as it relates to business ... Read Answer >>
  3. Why does the majority of my mortgage payment start out as interest and gradually ...

    When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the ... Read Answer >>
  4. What are some safe fixed-income investments?

    Learn what types of fixed income securities provide investors with safe options for protecting principal and providing steady ... Read Answer >>
  5. 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 >>
Hot Definitions
  1. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  2. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  3. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  4. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Merchandising

    Merchandising is any act of promoting goods or services for retail sale, including marketing strategies, display design and ...
Trading Center