When consumer prices rise, as they did last year, some investors may want to hedge against unexpected spikes in inflation. History shows Treasury Inflation-Protected Securities (TIPS) can be a useful tool for achieving this goal.1
TIPS vs. Inflation
TIPS outperformed inflation2 in 69% of the rolling, overlapping 12-month periods from 2001 to 20223 (see Exhibit 1).4 Put another way, TIPS helped investors preserve their purchasing power in more than two out of three of the 264 rolling one-year periods over this 22-year span, according to Dimensional research.
Here’s a TIP
Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
In simple terms, the principal value of a TIPS bond goes up when inflation rises (and vice versa). However, like all bonds, TIPS can be affected by changes in interest rates. When rates rise, the prices of existing bonds fall as new bonds issued with higher rates become more attractive. That means the total return of an inflation-protected security can be higher or lower than the annual inflation adjustment.
Still, for investors determined to protect their purchasing power as inflation rises, TIPS can be an effective option.
FOOTNOTES
- 1The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, investors are paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; that means interest payments, like the principal, rise with inflation and fall with deflation.
- 2Based on nonseasonally adjusted percentage change in Consumer Price Index for All Urban Consumers (CPI-U). Source: US Bureau of Labor Statistics.
- 3Rolling, overlapping returns measure the return for each 12-month period (January to December, February to January, March to February, etc.) between the start and end dates.
- 4Bloomberg US TIPS Index, January 2001 through December 2022. Bloomberg data provided by Bloomberg.
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