TIPS are U.S. Treasury bonds that raise principal with CPI and pay a fixed rate on that growing base—so your purchasing power stays intact. As of September 2025, the 10-year TIPS real yield stands at roughly 1.85%, while the 10-year breakeven inflation rate hovers around 2.41%. If you expect inflation to average above that, TIPS likely beat regular Treasuries of the same term.
But how do TIPS work? Are they a good investment for you? In this comprehensive guide, we’ll explore the fundamentals of Treasury Inflation-Protected Securities, their benefits and drawbacks, and how they fit into an investment portfolio.
Key Takeaways
- TIPS adjust your principal for inflation using the CPI-U index (with a ~3-month lag).
- Coupons are fixed in rate but vary in amount because they apply to the adjusted principal.
- At maturity, you get the greater of your original principal or the adjusted amount (deflation floor).
- Interest and inflation adjustments are federally taxable but exempt from state/local taxes.
- Best held in tax-advantaged accounts to avoid “phantom income.”
What Are Treasury Inflation-Protected Securities (TIPS)?
Treasury Inflation-Protected Securities (TIPS) are U.S. government bonds specifically designed to combat inflation. Issued by the U.S. Department of the Treasury, these securities adjust their principal value based on changes in the Consumer Price Index (CPI), ensuring that investors maintain their purchasing power over time.
How do TIPS work?
Unlike traditional fixed-income securities, which have a fixed principal value, TIPS adjust their principal amount to reflect inflation or deflation. Here’s how they function:
- Inflation-Adjusted Principal: When inflation rises (as measured by the CPI), the principal value of your TIPS increases. This ensures your investment grows along with rising prices in the economy.
- Fixed Interest Rate on a Growing Base: TIPS pay interest twice a year at a fixed rate. However, since this rate applies to the inflation-adjusted principal, your interest payments grow with inflation – giving you a double layer of protection.
- Built-In Safety Net: If the economy experiences deflation, your principal amount could decrease. However, when your TIPS mature, you’ll receive either the inflation-adjusted principal or your original investment – whichever is greater. This feature provides a valuable floor for your investment.
- Available Maturities: You can purchase TIPS with 5-year, 10-year, or 30-year terms, allowing you to align these investments with your specific financial timeline.
This inflation-adjusted structure makes TIPS an attractive option for those looking to protect their investments from rising prices.
Key Features of TIPS
TIPS come with distinct characteristics that set them apart from other types of government bonds.
1. Inflation-Linked Principal Adjustment
TIPS are directly tied to the Consumer Price Index (CPI), which measures inflation in the U.S. economy. As inflation rises, the principal value of TIPS increases, ensuring that investors receive higher interest payments.
2. Fixed Interest Rate
While the interest rate on TIPS remains fixed, the actual interest payments fluctuate because they are based on the inflation-adjusted principal. This means that investors receive higher interest payments when inflation is high and lower payments during periods of deflation.
3. Maturity Periods
TIPS are available in 5-year, 10-year, and 30-year maturities, allowing investors to choose the duration that best fits their financial goals.
4. Tax Considerations
One important factor to consider is that TIPS interest payments and inflation adjustments are subject to federal income tax. The increase in principal due to inflation is taxed as income in the year it occurs, even though investors don’t receive this money until maturity—this is known as “phantom income.”
5. Low Credit Risk
Because they are backed by the U.S. government, TIPS carry virtually no credit risk, making them one of the safest investments available.
Benefits of Investing in TIPS
Investing in Treasury Inflation-Protected Securities offers several advantages, especially for risk-averse investors looking to protect against inflation.
1. Protection Against Inflation
The primary benefit of TIPS is their inflation-adjusted principal, which ensures that investors do not lose purchasing power over time. This feature makes them particularly attractive during periods of high inflation.
2. Guaranteed Real Returns
Since TIPS are designed to keep pace with inflation, they provide real returns rather than nominal returns, making them a safer choice for those looking to maintain the value of their investment.
3. Diversification Benefits
TIPS can be a great addition to an investment portfolio because they have a low correlation with other asset classes, such as stocks and corporate bonds. This helps reduce overall portfolio risk.
4. Low Default Risk
Because TIPS are issued by the U.S. Treasury, they carry minimal credit risk, ensuring that investors receive their principal and interest payments as promised.
5. Available Through Multiple Investment Channels
TIPS can be purchased directly from the U.S. Treasury via TreasuryDirect, through mutual funds, or as exchange-traded funds (ETFs), making them accessible to both individual and institutional investors.
Potential Drawbacks of TIPS: What To Watch For
While TIPS provide a strong hedge against inflation, they also come with some disadvantages.
1. The “Phantom Income” Tax Challenge
Perhaps the biggest downside to TIPS is that you must pay federal income taxes on the inflation adjustments to your principal each year, even though you won’t receive this money until maturity. This creates what investors call “phantom income” – taxable gains without corresponding cash flow.
>> Tax-Smart Strategy: Consider holding TIPS in tax-advantaged accounts like IRAs or 401(k)s to avoid this annual tax burden.
2. Lower Initial Yields Compared to Traditional Bonds
TIPS generally offer lower yields than traditional Treasury bonds (T-bonds) of the same maturity because of their built-in inflation protection.
3. Underperformance During Deflation
While TIPS protect against inflation, they do not perform well in a deflationary environment. If deflation occurs, the principal value of TIPS decreases, reducing interest payments.
4. Market Volatility
While TIPS provide principal protection at maturity, their market prices can fluctuate if sold before maturity, particularly when interest rates or inflation expectations change significantly.
How to Buy TIPS
There are several ways to invest in Treasury Inflation-Protected Securities:
1. Direct Purchase Through TreasuryDirect
Investors can buy TIPS directly from the U.S. government via TreasuryDirect.gov. This method allows for commission-free purchases. Minimum $100, increments of $100, up to $10M noncompetitive bid at auction.
2. Brokerage Accounts
TIPS are also available through brokerage accounts, where they can be bought and sold in the secondary market.
3. TIPS Funds
For simplified management and instant diversification, consider TIPS-focused mutual funds or ETFs, which hold a variety of TIPS with different maturities.
Who Should Consider TIPS?
TIPS can be particularly valuable for:
- Retirees looking to preserve purchasing power on a fixed income
- Pre-retirees aiming to reduce portfolio risk as they approach retirement
- Conservative investors seeking government-backed security with inflation protection
- Investors with strong inflation concerns who want direct hedging against rising prices
- Portfolio balancers looking to diversify with assets that perform differently from stocks and conventional bonds.
TIPS vs. Other Inflation-Protected Investments
TIPS vs. I Bonds
Both TIPS and I Bonds are designed to protect against inflation, but they have key differences:
| Feature | TIPS | I Bonds |
|---|---|---|
| Interest Rate | Fixed, adjusts with inflation | Variable, based on inflation and fixed component |
| Tax Treatment | Taxed annually (including inflation adjustment) | Tax-deferred until redemption |
| Purchase Limit | No limit when bought in secondary market | $10,000 per person per year |
| Liquidity | Tradable in secondary market | Cannot be sold; must be redeemed |
| Minimum Holding | None (though early sales may result in loss) | Must hold at least 12 months; 3-month interest penalty if redeemed before 5 years |
TIPS vs. Traditional Treasury Bonds
While regular Treasury bonds offer higher initial yields, they do not protect against inflation. During periods of rising prices, the fixed payments from traditional bonds lose purchasing power, while TIPS maintain their real value.
Should I Buy TIPS Now?
- Check the breakeven: As of Aug 12, 2025, the 10-year breakeven inflation rate is ~2.3%.
- Expect higher inflation? → Favor TIPS.
- Expect lower inflation? → Favor nominal Treasuries.
- Near retirement? → Use TIPS as an “inflation insurance” sleeve in tax-advantaged accounts.
Building TIPS Into Your Investment Strategy
Rather than viewing TIPS as an all-or-nothing choice, consider these strategic approaches:
The Inflation Insurance Approach: Allocate a portion of your bond holdings to TIPS as a defensive measure against unexpected inflation spikes.
The Retirement Shield: Increase TIPS allocation as you approach or enter retirement to protect purchasing power when you can least afford to lose it.
The Barbell Strategy: Combine TIPS (for inflation protection) with higher-yielding bonds (for income) to balance your fixed-income portfolio.
The Tax-Efficient Placement: Hold TIPS primarily in tax-advantaged accounts to minimize the phantom income tax issue.
The TIPS Verdict: Balancing Inflation Protection and Investment Goals
Treasury Inflation-Protected Securities offer a unique combination of government-backed safety and built-in inflation protection that few other investments can match. While they won’t deliver spectacular returns during stable economic periods, their true value emerges when inflation threatens to erode your purchasing power.
For investors looking to hedge against inflation, TIPS can be a great addition to a diversified portfolio, especially when held in tax-advantaged accounts. By understanding how they work, their benefits, and potential drawbacks, you can make an informed decision on whether TIPS align with your financial goals.
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Frequently Asked Questions About TIPS
What happens to TIPS during deflation?
During deflation, your principal adjusts downward temporarily, lowering interest payments. However, TIPS include a guarantee that you’ll receive at least your original investment amount at maturity—effectively providing a floor that conventional bonds don’t offer during deflationary periods.
Do TIPS make sense when interest rates are rising?
The impact of rising rates on TIPS depends on why rates are climbing. If rates are rising due to inflation concerns, TIPS often outperform traditional bonds since their inflation adjustment offsets some price decline. The crucial metric is real interest rates (nominal rates minus inflation)—TIPS perform better when real rates remain stable or fall.
What’s the minimum required investment?
Through TreasuryDirect, you can start with just $100 and purchase in $100 increments. This accessibility sets TIPS apart from many alternative inflation hedges that require substantial capital. For TIPS funds, minimums vary but typically match standard mutual fund or ETF requirements.
How do TIPS counter inflation effectively?
TIPS employ a dual defense system against inflation: first, your principal automatically increases with the CPI inflation rate; second, because interest payments are calculated on this growing principal, your income stream expands alongside rising prices. This comprehensive approach shields both your capital and income from inflation’s erosive effects.
When are TIPS worth their lower yield?
The “breakeven inflation rate” offers a simple decision tool—if you expect inflation to exceed the difference between conventional Treasury and TIPS yields, choose TIPS. For instance, with a 1.8% breakeven rate, TIPS will outperform if inflation averages above 1.8% over your holding period. Your risk tolerance and portfolio diversification needs should also factor into this calculation.
Can I exit TIPS before maturity?
Yes, TIPS can be sold on the secondary market, though prices fluctuate based on current rates and inflation expectations. TreasuryDirect purchases require an extra step—transferring to a broker first—while TIPS held in brokerage accounts can be sold with a standard trade. Either way, selling before maturity means accepting market value rather than guaranteed principal protection.
How do TIPS compare to savings accounts?
While both preserve principal, savings accounts often lose purchasing power during inflationary periods because their rates rarely keep pace with rising prices. TIPS, by design, maintain real value regardless of inflation levels. Additionally, savings accounts carry FDIC insurance up to $250,000, while TIPS have unlimited backing from the U.S. government—making them suitable for larger sums.
Alvin Carlos, CFP®, CFA is a fee-only financial planner, in Washington, D.C. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is the founder of District Capital, a financial planning firm designed to help professionals in their 30s and 40s maximize their money and retire by 55, through holistic financial planning and research-driven investing. Schedule a free discovery call today.
