When the Consumer Price Index (CPI)—a key measure of inflation—jumped 5.4% this past June, some investors may have turned to Treasury Inflation-Protected Securities (TIPS) to help soften the potential blow. After all, TIPS’ principal value is indexed to the CPI, so when inflation rises, their value and interest payments rise as well.
“TIPS are often seen as the antidote to rising inflation,” says Collin Martin, director and fixed income strategist at the Schwab Center for Financial Research. “But like most investments, TIPS have some trade-offs investors shouldn’t overlook.”
Chiefly, TIPS tend to offer lower yields than traditional Treasuries. This is by design: Investors in TIPS accept lower yields because their principal value and coupon payments rise when inflation rises.
That said, it’s important to consider the break-even inflation rate—or the difference in yields of a TIPS and a comparable Treasury—before investing. (The Federal Reserve of St. Louis publishes break-even inflation rates.) In July 2021, for example, the break-even rate for a 10-year TIPS was 2.36%, meaning inflation would need to exceed that rate over the life of the bond in order for the TIPS to outperform a comparable Treasury.1 For context, the CPI surpassed that rate a handful of times over the past decade, but during only one period—from March 2011 through March 2012—did it remain above that reading for longer than a few months.2
“If inflation remains modest going forward, TIPS returns are likely to be held in check,” Collin says. “But for investors who anticipate a period of sustained higher inflation, TIPS are likely one of the best ways to help insulate their portfolios.”
What You Can Do Next
Need help determining if TIPS make sense as part of your fixed income strategy? Call a Schwab fixed income specialist at 877-566-7982.