What to Know About Treasury Inflation-Protected Securities (TIPS)

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Inflation is the monster in the closet for many investors, and that's why Treasury inflation-protected securities (TIPS) are objects of great interest lately. The government-guaranteed bonds are designed to beat inflation year after year, so they provide a measure of portfolio protection against rising prices — but they are no panacea, and they take some figuring out.

Still, they may be worth a look, as the worry over rising prices is palpable these days. According to the University of Michigan's April consumer confidence survey, Americans believed that inflation would average 6.5% over the next 12 months. That's the highest reading since 1981, and it's well more than twice the 2.4% rise in the consumer price index (CPI), the government's main inflation gauge, over the previous 12 months.

The angst is understandable. The inflationary impact of the Trump administration's tariff policy is uncertain, and the scars from the 9% inflation rate reached in June 2022 haven't faded. Inflation tends to be sticky — that is, prices that go up often don't go down. Even though the rate of inflation has fallen since its peak, prices are still up a cumulative 24% since March 2020, according to the CPI.

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It's no wonder funds that invest in TIPS have seen net inflows of $9.2 billion over the past 12 months, according to Morningstar, the Chicago mutual fund tracker. If you're worried about inflation, read on to see whether TIPS are right for your portfolio.

How TIPS work

The government issues 5-, 10- and 30-year TIPS, which pay a fixed rate on a principal that adjusts in line with changes in the CPI.

As an example, let's look at a recent Treasury issue of 10-year TIPS. The annual fixed interest rate is 2.125%, payable every six months — a rate that's about as appealing as last week's oatmeal. The real attraction of TIPS is that the principal value of your bond can go up (or down) according to changes in the CPI.

Let's say that the CPI increases 3% in the 12 months after issue. The Treasury will then add 3% to your bond’s principal, boosting a $1,000 bond to $1,030, for example, and your interest payment from $21.30 to $21.94. (This simplified example illustrates an annual rate, but remember, TIPS pay twice a year.)

TIPS funds gained an average 3.4% in 2024, making them one of the best-performing bond fund categories — which is also an indication of how awful the bond market was in general.

And that brings us to our first caveat: "They are still bonds," says Thomas Urano, chief investment officer at Sage Advisory Services. Despite all their anti-inflation merits, TIPS prices will go south when the bond market does, at least partway.

If you own individual TIPS to maturity, price fluctuations won't matter much. You'll get your interest and principal as promised. If you sell your TIPS before they mature, however, you'll get whatever the market will pay, which could be more or less than the current rate of inflation.

Consider the following TIPS tips before you buy:

Watch out for falling prices. If we enter a period of falling prices — deflation — then the Treasury would subtract that amount from your bond’s principal value. Deflation is unusual, but not unknown. The CPI went negative in 2009 and 2015. But even if the CPI deflates for the life of the bond, you're guaranteed your full initial principal at maturity.

Understand the real yield. The real, or inflation-adjusted, yield from TIPS is a gauge of future inflation expectations.

For example, if the 10-year TIPS yield is 2.13% and the 10-year Treasury note yield is 4.35%, then Wall Street is expecting an average 2.2% inflation rate over the next 10 years. The TIPS breakeven — the difference in nominal yields between TIPS and Treasury securities of comparable maturities — has ranged between 0.04% and 3.02% since 2023, so a 2.2% real yield is a relatively high return.

Be ready for Uncle Sam to take a cut. Your interest is subject to federal income taxes, though not state or local taxes.

But there’s a catch: You also owe tax on the inflation adjustment to your principal in the year you receive it — even though you don’t realize that income until the bond matures or you sell it. That makes TIPS in general, including TIPS funds, best used in a tax-deferred account.

How to buy TIPS

You can buy individual TIPS in $100 increments for free from the Treasury at Treasury Direct. You can also buy TIPS through your brokerage. Or you might prefer using mutual funds and exchange-traded funds.

Short-term funds invest in TIPS with maturities of five years or less, according to Morningstar. These funds tend to be less volatile than longer-term TIPS funds, says Chun Wang, portfolio manager at the Leuthold Group, a money management firm.

As with all funds, you should prefer those with low expenses — 0.70% or less. Consider T. Rowe Price U.S. Limited Duration TIPS Index (TLDTX). The fund, which charges a 0.21% fee, has outpaced its peers over the past 12 months with an 8.2% gain.

Also consider American Century Short Duration Inflation Protected Bond (APOIX), which charges 0.70% in management fees. The fund has beaten the average short-term TIPS fund over the past one- and five-year periods. (Returns, prices and other data are as of April 30.)

ETFs worth a look include iShares 0-5 Year TIPS Bond (STIP), which weighs in with a 0.03% expense ratio, and Vanguard Short-Term Inflation-Protected Securities (VTIP), which charges 0.03% a year. Both have beaten the average ETF in their category over the past three- and five-year periods.

TIPS funds with a longer-term orientation can be riskier than their short-term brethren.

"They are definitely more sensitive to interest rates," says Sam Millette, fund manager at Commonwealth, an investment advisory firm.

Specifically, these funds are likely to post a bigger loss than short-term TIPS funds during a period of rising interest rates. (Bond prices and interest rates move in opposite directions.) A TIPS interest payment will offset some, but not all, of the pain of rising interest rates. In 2022, for example, the average TIPS fund lost 9.0%.

Still, if you have a longer investing time horizon, then a longer-term TIPS fund is a good choice, says Millette. Schwab U.S. TIPS (SCHP), which tracks a Bloomberg U.S. TIPS index, invests in a full range of maturities. The portfolio recently had an effective maturity of 7.1 years and a duration of 6.4.

Duration is a measure of interest-rate sensitivity; a duration of 6 implies a 6% loss in net asset value if interest rates rise one percentage point. The ETF finished in the top half of its category for nine of the past 10 calendar years (the exception was 2022), and it charges an expense ratio of 0.03%.

Finally, don’t wait until the CPI has already soared to buy TIPS. Remember that TIPS are priced according to what Wall Street expects for inflation over time, not today’s inflation rate. Those who bought TIPS funds during the 2022 inflation spike took a big hit because of the higher interest rates that tend to follow such consumer price surges.

For that reason, says Sage Advisory’s Urano, "TIPS are not a cure-all."

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

John Waggoner has put personal finance and investing into plain English for more than three decades. He was a senior columnist for InvestmentNews and, prior to that, USA TODAY's personal finance columnist for 25 years. He has written for Morningstar, The Wall Street Journal, and Money magazine. Waggoner has also written three books on finance and investing. He has an undergraduate and graduate degree in English literature and is working on his Certified Financial Planner designation. He lives in Vienna, Virginia.