Treasury inflation-protected securities, also known as TIPS, are treasury securities that make adjustments for inflation as reflected in the Consumer Price Index. TIPS are an effective way for fixed- income investors to eliminate inflation risk.TIPS have a fixed interest rate that is paid semi-annually. The inflation adjustment is also made on a semi-annual basis. The adjustment is made to the bond’s par value rather than the interest rate. Adjusting the bond this way not only protects the bond’s interest payment from inflation, but also protects the bond’s face value. For example, an investor purchases a $1,000 TIPS from the US Treasury with a 4% stated interest rate. Assume that inflation, as measured by the consumer price index, is 12% for the first year of this bond. At the beginning of the second year, the bond’s face value is adjusted by 12% ($120) to $1,120. The 4% interest will then be paid on this new face value amount. TIPS come with some tax concerns. The Internal Revenue Service considers an adjustment to a security’s face value as taxable income. Therefore, in the example given, the investor would have to include that $120 adjustment to face value in his taxable income even though he did not actually receive the $120 in cash. Because of this tax treatment, most investors prefer to own TIPS in mutual funds or, even better, in their tax-deferred retirement accounts.