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Some TIPS for investing in inflation

These government bonds pay more interest when inflation rises.

Key takeaways

  • Inflation poses a threat to bondholders because rising prices reduce the purchasing power of the fixed rates of interest that their bonds pay.
  • Treasury Inflation-Protected Securities (TIPS) are bonds whose principal and interest rate payments rise along with inflation.
  • TIPS are usually more expensive than conventional bonds and they may lose value if inflation is lower than expected.
  • Investors should consider whether adding inflation protection to their diversified portfolios makes sense.

While prices that consumers pay for products and services aren't rising nearly as sharply as they did several years ago, they are still going up. Add to that new tariffs on imported good, and you may want to consider adding some inflation protection to your portfolio.

The Bureau of Economic Analysis Personal Consumption Expenditure (PCE) measure of inflation has been ticking modestly upward since September and Collin Crownover of Fidelity's Asset Allocation Research Team believes inflation could rise above 3% later this year. "Historically, it has been common in the US and other developed countries to see a second wave of inflation after the initial surge subsides," he says.

Why inflation matters for bond investors

Inflation is bad news for most types of bonds because it makes their fixed-interest payments less valuable. Bonds generally offer a series of fixed-interest payments that represent a percentage of the face value of the bond. When inflation picks up and prices rise, the purchasing power of the interest payment decreases, meaning those fixed payments buy less stuff.

To help reduce the risk that inflation poses to bondholders, the US Treasury created Treasury Inflation-Protected Securities (TIPS) in 1997. These are bonds whose principal and interest payments are designed to rise when inflation does. They are available in 5-year, 10-year, and 30-year maturities.

How TIPS adjust to inflation

TIPS' yields are based on their current amount of principal. When inflation rises, the principal of TIPS adjusts higher, and the payments go up along with it. Let's look at a hypothetical example to understand how TIPS do this.

This example is for illustrative purposes only and does not represent the performance of any security. Consider your current and anticipated investment horizon when making an investment decision, as the illustration may not reflect this. The assumed rate of return used in this example is not guaranteed.

Risks of TIPS

TIPS pose very little risk of default because they are backed by the full faith and credit of the US government. However, they do not protect bondholders from all types of risk. If inflation were to give way to deflation, principal and interest rate payments on TIPS would adjust downward, and investors may wish they held conventional bonds instead. It's also possible to lock in a loss in real terms if you buy a TIPS with a negative real yield and hold it to maturity.

TIPS are also subject to interest rate risk, just like other bonds. That means when interest rates rise, the market value of bonds is likely to fall. Rate risk may be managed by holding individual TIPS bonds to maturity, as in a bond ladder. If you hold TIPS until they mature, you will receive either the adjusted principal or the original principal, whichever amount is greater.

TIPS and taxes

Semi-annual interest payments on TIPS are subject to federal income tax, just like payments on conventional Treasury securities.

Any increase in the value of the TIPS principal is subject to federal tax in the year that it occurs—even though you won't receive any income from the increase. On the other hand, when the TIPS matures or is sold, you will only pay federal tax on the final year's increase in principal while receiving the full increase in principal since the date of initial purchase. Like all Treasury securities, TIPS are exempt from state and local income taxes. Investors should consult their tax advisors regarding their specific situation prior to making any investment decisions with tax consequences.

Watching the breakeven rates

One way investors can determine whether TIPS or conventional Treasurys may make more sense for their portfolios is to look at what is called the breakeven inflation rate. This is the rate of inflation at which a TIPS and a conventional Treasury of the same maturity would both deliver the same inflation-adjusted return until they mature. For example, if a 5-year TIPS yielded 1.57% while a conventional 5-year Treasury bond paid 4.10% as of February 26, 2025, the breakeven for the 5-year bonds would be 2.53%. If actual inflation exceeds the breakeven rate in the future, the adjustment to the TIPS will eventually provide a higher real return than the conventional bond. However, if inflation comes in lower than the breakeven rate, the conventional bond will provide a better return.

Finding ideas

Investors interested in diversifying their portfolios with TIPS can choose from individual bonds, mutual funds, or exchange-traded funds. The approach you choose should reflect your ability and interest in researching your investments, your willingness to track them on an ongoing basis, the amount of money you have to invest, and your tolerance for various types of risk. There are pros and cons for both individual bonds and bond funds. In some cases, it may make the most sense to own both. Learn more about the differences between individual bonds and funds here: Bonds vs. bond funds

TIPS are also used by professional investment managers to help protect portfolios from specific risks, says Lars Schuster, institutional portfolio manager with Strategic Advisers, LLC. "While higher inflation can be problematic for some bonds, TIPS exposure might help protect the value of the fixed income portion of a well-diversified portfolio," he says.

You can buy TIPS directly from the US government at auctions spread throughout the year and at Fidelity.com. You can also buy and sell individual TIPS with various maturities and prices from other investors in the secondary market. Fidelity.com does not charge fees or mark-ups on these transactions.

Fidelity also offers research tools including the Mutual Fund and ETF evaluators on Fidelity.com.

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The views expressed are as of the date indicated and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author, as applicable, and not necessarily those of Fidelity Investments. The third-party contributors are not employed by Fidelity but are compensated for their services.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

As with all your investments through Fidelity, you must make your own determination whether an investment in any particular security or securities is consistent with your investment objectives, risk tolerance, financial situation, and evaluation of the security. Fidelity is not recommending or endorsing this investment by making it available to its customers.

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Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Lower yields - Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.

Interest rate risk - Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.

Call risk - Some Treasury securities carry call provisions that allow the bonds to be retired prior to stated maturity. This typically occurs when rates fall.

Inflation risk - With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to TIPS, which are inflation protected.

Credit or default risk - Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.

High-yield/non-investment-grade bonds involve greater price volatility and risk of default than investment-grade bonds.
The Fidelity Mutual Fund Evaluator is a research tool provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Information supplied or obtained from these Screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange-traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk. Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.

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