Inflation continues to be a concern these days, and many investors are looking for investments that can keep pace with, or hopefully beat, the rate of inflation. As a result, Treasury Inflation-Protected Securities, or TIPS, have become a popular investment option.
But investing in TIPS isn't always straightforward. They have many unique characteristics that can make the investing experience a bit confusing. Here are answers to some of the most frequently asked questions about the TIPS market:
1. What are Treasury Inflation-Protected Securities?
Treasury Inflation-Protected Securities, or TIPS, are a type of U.S. Treasury security whose principal value is indexed to the rate of inflation. When inflation rises, the TIPS’ principal value is adjusted up. If there’s deflation, then the principal value is adjusted lower. Like traditional Treasuries, TIPS are backed by the full faith and credit of the U.S. government.
Although there are many measures of inflation, TIPS are referenced to one specific index: the Consumer Price Index, or CPI, a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, published monthly by the U.S. Bureau of Labor Statistics.
2. Will TIPS coupon payments fluctuate with the level of inflation, as well?
Yes. Just like traditional Treasuries, TIPS have fixed coupon rates and make semiannual interest payments. While the coupon rates are fixed, the actual coupon payments can fluctuate based on the underlying principal value. The table below provides a hypothetical look at a TIPS principal value and coupon payment based on a constant 2% rise in inflation.