Understanding Investing
Treasury Inflation-Protected
Securities (TIPS)
For many investors, inflation-protected bonds – specifically designed to protect against rising
consumer prices – are an effective way to guard against inflation. Treasury Inflation-Protected
Securities, known as TIPS, are one of the most attractive members of this asset class.
Inflation is an increase in the price of goods and services
and, in effect, shrinks the value of your money. The dollar
you invest today will be less valuable tomorrow, posing
a serious threat to investors. Inflation is particularly
concerning for bondholders since it can erode the purchasing
power of future interest and principal payments.
In the U.S., a widely accepted measurement of inflation is
the Consumer Price Index (CPI). As the chart below shows,
prices have risen steadily in the U.S. since the end of World
War II, signaling a steady rise in inflation.
HOW DO TIPS WORK?
Treasury Inflation-Protected Securities, or TIPS, are
inflation-protected bonds (IPBs) that are issued by the U.S.
Treasury. Their face value is pegged to the CPI and adjusted
in step with changes in the rate of inflation. The Treasury
then pays interest on the adjusted face value of the bond,
creating a gradually rising stream of interest payments
as long as inflation continues to rise. At maturity, a TIPS
investor will receive the original face value plus the sum of
all the inflation adjustments since the bond was issued.
It works like this: Suppose you invest $1,000 in a new 10year TIPS with a 2% coupon rate. If inflation is 3% over the
next year, the face value will be changed to $1,030 and the
annual interest payment would be $20.60, or 2% (the coupon
rate) of the adjusted principal and so on. In a deflationary
environment, the reverse would be true: the face value and
interest payments would decrease, but still keep pace with
the now lower cost of goods and services.
As a result, TIPS and other IPBs offer a “real” rate of return
– the actual return of an investment after inflation is taken
into account. A traditional bond, on the other hand, offers
a “nominal” return. It maintains a fixed face value until
maturity, with no adjustments for inflation. For example,
if you’re receiving a 5% return on a traditional bond and
inflation is rising at 3%, your “real” return is actually only 2%.
WHAT ARE SOME OTHER ADVANTAGES OF INVESTING IN TIPS?
• TIPS can potentially be an effective portfolio diversification
tool. Because TIPS have a low correlation with other types
of investments, they may reduce overall portfolio volatility.
• TIPS offer the government’s assurance that investors will
never receive less than the original face value of the bond
at maturity, even in the event of deflation during the life
of the bond.
FIGURE 1: THE RISING COST OF A DOLLAR
Based on the CPI, what one dollar could buy in 1945 would cost
$13.26 today.
$14
12
10
Dollar value
WHAT IS INFLATION AND WHY SHOULD
I BE CONCERNED ABOUT IT?
8
6
4
2
0
‘45 ‘46 ‘51 ‘56 ‘60 ‘65 ‘70 ‘74 ‘79 ‘84 ‘88 ‘93 ‘98 ‘02 ‘07 ‘12 ‘15 ‘16
Years
Source: Bloomberg, as of 30 November 2016.
This chart is not indicative of the past or future performance of any PIMCO product.
HOW DOES THE RISK ON TIPS COMPARE WITH OTHER
BOND INVESTMENTS?
investors monthly. You pay the federal income tax, of course,
but you’re also receiving the income you’re paying it on.
TIPS do not carry credit risk thanks to their government
guarantee but, like all bonds, TIPS are subject to interest
rate risk. TIPS should perform better in a rising interest rate
environment than conventional Treasury bonds because their
inflation adjustments provide better price protection, but only
when rates are rising as a result of increasing inflation. If rates
were to rise in an environment of low or no inflation, TIPS’
prices could decline.
Investors who own TIPS through a mutual fund should also
be aware that the fund may perform differently than the
underlying bonds. Individual TIPS guarantee an inflationadjusted return if held to maturity, but there is no guarantee
for a fund; a portfolio manager may buy or sell TIPS before
maturity, which could lead to gains or losses.
Investors who purchase individual TIPS should be aware
of a phenomenon called “phantom income” – TIPS inflation
adjustment to the face value of the bond is taxable in the year it
occurs even though you won’t receive the bond’s full value until
it matures. This differs from a mutual fund, which pays out both
interest income and the income from principal adjustments to
HOW CAN I INVEST IN TIPS?
You can purchase TIPS directly from the U.S. Treasury for a
minimum purchase amount of $1,000. You may also choose
a mutual fund or exchange-traded fund that invests in TIPS,
which offers the additional benefits of professional management.
Your investment professional can help you decide which
investment is right for you.
FIGURE 2: HOW TIPS CAN GROW IN VALUE
TIPS can help guard against inflation by adjusting their face value with changes in the rate of inflation. Interest is then paid on the adjusted face value of the bond.
Deflation (negative CPI)
■
Inflation (positive CPI)
No change
Total distribution
■
1
2
3
4
5
6
7
8
9
10
Year
11
12
13
14
15
16
17
18
19
20
This chart is a hypothetical illustration of how TIPS are designed to operate in different economic environments. It is not based on any statistical information and is not indicative of any PIMCO product. TIPS
adjust their face value according to changes in the Consumer Price Index. This means during periods of rising inflation the amount of the monthly distribution is expected to increase and during periods of
deflation the amount of the monthly distribution is expected to decrease.
A word about risk: Diversification does not ensure against loss. Investing in the bond market is subject to risks, including
market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by
changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with
shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this
risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility.
Bond investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a
government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline
in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Portfolios
that invest in such securities are not guaranteed and will fluctuate in value.
How can I learn more?
Visit pimco.com
Call your investment professional
Call us at 888.87.PIMCO
This material has been distributed for informational purposes only and should not be considered as investment advice or a
recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from
sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any
other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in
the United States and throughout the world. PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY 10019, is a
company of PIMCO. © 2017 PIMCO
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The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation in U.S. consumer prices as determined by
the U.S. Bureau of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at
any given time. It is not possible to invest directly in an unmanaged index.