TIPS can provide an investor protection against inflation

Although inflation has eased considerably, in many ways, it is still alive and well.

The consumer price index, which measures the cost of a wide-ranging basket of goods and services, has fallen gradually from a 9.1% pandemic-era peak in June 2022 to 3% in January. But it is still above the Federal Reserve’s 2% goal.

“The progress toward 2% inflation has stalled out, and the Fed knows it,” said Greg McBride, chief financial analyst at Bankrate.com. Federal Reserve officials have also expressed concern about the impact tariffs may now have on inflation.

TIPS are issued and backed by the U.S. government like typical Treasury bonds, however, these securities are meant to hedge against rising consumer prices.

To compare, regular Treasury bonds could lose value over time if the interest they earn is below the rate of inflation. Currently, the bellwether 10-year Treasury bond is yielding just below 4.5%. (The same goes for the low yields on certificates of deposits when it comes to protecting long-term buying power.)

Alternatively, the principal portion of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. In this case, as inflation rises, the value of the principal will rise as well to maintain its value.

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For example, an investor buys $1,000 in TIPS at a fixed rate of 1%. If inflation rises by 2%, the principal will rise to $1,020. The rate will stay the same 1%, but future interest payments are multiplied by the new principal amount of $1,020, so payments are $10.20 for the year (or $5.10 every six months, since TIPS pay interest twice a year).

TIPS are issued in 5-, 10- and 30-year maturities and when a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.

The threat of tariffs on imports is causing more investors to consider increasing their exposure to TIPS to mitigate inflation concerns, according to a recent report by Wells Fargo Investment Institute.

“TIPS continue to be a valuable tool for protecting purchasing power in an inflationary environment,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York.

“With yields currently near decade highs, they’re certainly more attractive than in recent years,” said Boneparth, a member of the CNBC Financial Advisor Council.

However, TIPS aren’t immune from losses even in an inflationary environment, according to Colin Gerrety, a certified financial planner and client advisor at Glassman Wealth Services in Tysons Corner, Virginia.

“Just look at 2022 as an example,” he said.

“Let’s say inflation spikes and interest rates rise at the same time,” he said, as they did that year. “TIPS might actually lose money if the negative impact from the rise in rates exceeds the adjustment that occurs due to inflation.”

In 2022, rising interest rates hurt TIPS and other bonds; TIPS had a -11.85% return that year, although that was still better than U.S. Treasurys.

Consider the potential impact of tariffs on inflation going forward, said Winnie Sun, co-founder and managing director of Sun Group Wealth Partners, based in Irvine, California.

She recommends a strategy that combines fixed-income TIPS with dividend-paying stocks and laddered CDs for short-term cash flow needs. Sun is also a member of CNBC’s Advisor Council. 

“I usually advise clients to view TIPS as one part of a diversified portfolio rather than a standalone solution,” Boneparth also said.

“While they offer the benefit of inflation-adjusted returns, it’s important to consider factors like tax treatment and the potential for lower returns if inflation moderates,” he added.

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