What are Treasury Inflation Protected Securities?
Treasury inflation protected securities (TIPS) are United States government securities introduced to the financial markets in 1997 that are designed to provide protection against inflation. They are categorized as fixed income investments because they are a type of bond. Treasury inflation protected securities are largely considered to be extremely safe investments because there is not a lot of risk of losing capital or money involved, but investors should not expect blockbuster profits, either. These investments are designed to protect wealth as opposed to growing the initial investment at an aggressive rate, and they are largely used to provide diversification to an investment portfolio.
Like bonds, Treasury inflation protected securities have a face value and grow at an interest rate. The interest on TIPS is typically paid twice a year at a predetermined fixed interest rate. Even though a fixed rate is applied to TIPS, the interest rate can vary each pay period based on changes in the face value or principal amount of the investment, because there is a direct correlation between the two. TIPS also have a predetermined maturity date, at which time the security expires. An investment into TIPS is a bet that inflation will grow over the duration of the bond.
At maturity, the investor is paid either the original or adjusted principal amount of the investment, whichever amount is greater. The principal amount is structured so that the amount increases when there is inflation the U.S. economy. It sheds worth during times of a deflationary economy.
Inflation is measured by one major U.S. economic barometer dubbed the Consumer Price Index (CPI). When the index increases in value, it represents greater inflation. When the CPI declines, it is representative of less inflation and could lead to a deflationary environment. Historically in the U.S. economy deflation is rare but it poses a minor threat because payout is greater with higher inflation.
Treasury inflation protected securities have a maturity date on them, but these expiration times are available only in certain durations. These government securities are issued by the Federal Reserve and can be purchased and held for five-, 10- or 30-year increments. Typically, these securities can be purchased via auction in increments of $100 US Dollars (USD), as well. If an investor does not want to hold the investment for the duration of the term, TIPS can be sold in what's known as a secondary market, which is a regulated marketplace that allows investors to sell securities to one another prior to the expiration date.
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