TIPS (Treasury Inflation-Protected Securities)

TIPS, or Treasury Inflation-Protected Securities, are US government bonds engineered to defend an investor's purchasing power. Their principal value adjusts up (or down) with the Consumer Price Index, so as inflation rises, both the bond's principal and the interest paid on it increase. At maturity you receive the inflation-adjusted principal, guaranteeing a return of your original purchasing power backed by the US Treasury.

This makes TIPS fundamentally different from conventional Treasuries. A regular Treasury pays a fixed nominal coupon, and inflation quietly eats into the real value of those payments. TIPS instead lock in a real yield: whatever inflation turns out to be, the holder's purchasing power is preserved plus that stated real return. They are, in effect, the purest available hedge against unexpected inflation.

TIPS are not risk-free, however. Like all bonds they carry duration — sensitivity to changes in real interest rates. This surprised many investors in 2022, when the Federal Reserve raised rates aggressively: real yields jumped, and intermediate and long TIPS funds fell sharply even though inflation was high. TIPS hedge inflation, but they do not hedge rising real rates, and the two do not always move together.

In asset allocation, TIPS occupy a specific role: an inflation-defense sleeve distinct from nominal bonds. Strategies on this site such as the Yale Endowment (Swensen) Portfolio deliberately hold TIPS alongside conventional bonds so the portfolio has protection whether the threat is deflationary recession or an inflationary surprise. Because their expected real return is modest, keeping costs low with a cheap TIPS index fund is especially important.