Treasury Inflation Protected Securities: Do They Belong in Your Portfolio?

Understanding the basics of these bonds can show you their true value.

Sep 4, 2014 at 7:00PM

U.S. Treasury Building, Washington, D.C. Image courtesy Wikimedia Commons.

Despite the allure of huge potential gains in the stock market, most investors need to keep at least some of their money in more conservative investments. Yet for years, investment experts have warned that rising interest rates would crush the value of most bonds, causing unexpected losses for bond investors. As fears of inflation rise, though, more investors are looking at a special type of bond known as Treasury Inflation Protected Securities, or TIPS. But do TIPS make sense for your portfolio? Let's look at what makes Treasury Inflation Protected Securities so unusual and see whether they can help you in ways that ordinary bonds can't.

Fighting against inflation with Treasury Inflation Protected Securities

For most bonds, one of the biggest threats is inflation. To buy a typical bond, you pay a fixed amount up front, agreeing to take fixed amounts of interest at various intervals. When the bond matures, you get the original amount of your investment back along with the final interest payment.


Source: U.S. Treasury.

By the time the bond matures, though, inflation has reduced the purchasing power of the money you initially invested. For instance, with a typical $1,000 30-year Treasury bond, you're guaranteed to get the $1,000 in principal back at maturity -- but by the time 30 years has passed, the purchasing power of that $1,000 will have been cut in half, even assuming modest inflation rates of around 2.5%.

The government designed Treasury Inflation Protected Securities to fight the impact of inflation. Rather than giving your original investment back, TIPS have their final payment at maturity adjusted upward to reflect inflation throughout the period. In addition, interest payments rise steadily in line with moves in the Consumer Price Index, which is the government's gauge of inflation for these purposes. As a result, using the same 2.5% inflation assumptions as above, a $1,000 30-year TIPS bond would pay out almost $2,100 at maturity 30 years from now -- equivalent to the purchasing power of $1,000 today.

The pros and cons of Treasury Inflation Protected Securities

Because TIPS are indexed to changes in inflation, the inflationary pressures that affect regular bonds leave TIPS largely unscathed. So when interest rates on regular bonds rise because of inflation, the interest rates on TIPS -- and thus the price of TIPS -- will remain relatively stable.

The Federal Reserve plays a vital role in the bond market. Image source: Dan Smith.

Moreover, from a planning standpoint, using TIPS for future income needs is easier. With regular bonds, you have to worry about the unknown impact of inflation on purchasing power. With TIPS, though, you're assured that the value of the bond at maturity will keep up with inflation.

But there are some trade-offs with Treasury Inflation Protected Securities. The most obvious is that the interest rate you get on TIPS is much lower than on regular bonds. That's because with regular bonds, the interest payments are what compensate you for inflation risk, while TIPS back-load the impact of inflation into the maturity payment. In fact, interest rates on short-term TIPS have been persistently negative in recent years, and even long-term TIPS have seen their rates stuck in a 0% to 1% range for a while now. At the same time, if interest rates on TIPS rise -- which can happen if the bond market anticipates rate increases for reasons other than inflation -- then they can lose principal value as well if not held until maturity.

Also, the way that TIPS get taxed is complicated. Even though you don't receive the inflation adjustment until the bond matures, the IRS forces you to include the rise in value that comes from inflation each and every year in your taxable income. That increases the tax cost of TIPS and makes them most suitable for use in tax-deferred retirement accounts like IRAs.

With fears of inflation starting to rise, Treasury Inflation Protected Securities are getting more attention from investors. Although they won't replace all of your allocation to the bond market, TIPS can be a good way to diversify your bond portfolio from the negative impact of inflation going forward.

Top dividend stocks for the next decade

Beyond bonds, though, the smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers