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 Treasury inflation protected securities (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.

  1. TIPS Spread

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

    An inflation trade is an investing scheme or trading method that ...
  3. Principal

    Principal is the amount borrowed on a loan or put into an investment.
  4. 30-Year Treasury

    The 30-Year Treasury is a U.S. Treasury debt obligation that ...
  5. Index-Linked Bond

    An index-linked bond is a bond in which payment of income on ...
  6. Principal-Protected Note - PPN

    A principal protected note is a fixed-income security that guarantees ...
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. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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 ...
  7. Investing

    Investors Bet on Inflation-Fighting ETFs

    Inflation data indicate prices are inching higher. Investors can fight this scenario with these ETFs.
  8. Retirement

    7 Tools For Rebuilding Retirement Savings

    If your nest egg has taken a hit, these conservative investments could help get you back on track.
  9. Investing

    TIPS ETFs: No Inflation, No Reason to Buy

    No inflation means there's no reason to buy TIPS ETFs.
  1. What is inflation and how should it affect my investing?

    The rate of inflation is important as it represents the rate at which the real value of an investment is eroded and the loss ... Read Answer >>
  2. What are the responsibilities of the principal in a company?

    Learn what a principal is as it relates to business management, and the differences between all the meanings. Find out what ... Read Answer >>
Hot Definitions
  1. Liquidity

    Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's ...
  2. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  5. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center