Treasury Inflation-protected Securities (TIPS)

Revised by Ricardo Ribeiro

The inflation-protected securities pay the inflation rate plus interest. 

Maybe the best way to explain is with an example. Note that I am simplifying the calculations to make the example easier to understand. 

Let’s say the current inflation rate is 2%. Then, a government bond might pay 2.5% interest, and an inflation-protected security might pay something around inflation plus 0.5% interest.

In case 1, let’s say inflation rises to 3%.

The government bond’s holder will still receive the 2.5% interest. That would mean a 0.5% loss against inflation. 

The inflation-protected security’s holder will receive 3.5% (3% inflation plus the 0.5% interest). That is a 0.5% profit against inflation.

In case 2, let’s say inflation falls to 1%.

The government bond’s holder will still receive the 2.5% interest. That would mean a 1.5% profit against inflation. 

The inflation-protected security’s holder will receive 1.5% (1% inflation plus the 0.5% interest). That is the same 0.5% profit against inflation.

These securities present a good way to protect your portfolio against rising inflation.

Beginners don't always understand inflation-protected securities. But, beginner investor or not, it is always a good idea to take steps to protect your investment portfolio. In the right proportion, these securities are a good way to add some extra protection.

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