TIPS (Treasury Inflation-Protected Securities)
TIPS are US Treasury bonds whose principal rises with inflation as measured by the CPI, protecting investors' purchasing power.
With a regular bond, inflation erodes the real value of fixed payments. TIPS address this by adjusting their principal value based on the Consumer Price Index. The fixed coupon rate is applied to the adjusted principal, so interest payments rise along with inflation.
Example: you hold $1,000 of TIPS with a 1% coupon. If inflation runs at 3% for a year, the principal becomes about $1,030, and the annual interest becomes about $10.30. At maturity you receive the inflation-adjusted principal or the original amount, whichever is greater.
The yield on TIPS is a real yield, meaning a return above inflation. Comparing it with the yield on a regular Treasury of the same maturity gives the breakeven inflation rate, a market-based estimate of expected inflation.
TIPS still carry interest rate risk: their prices can fall when real yields rise. In taxable accounts, the yearly inflation adjustment is taxed as income even though it is not paid out until maturity.