You’ve probably heard about Treasury Inflation-Protected Securities (TIPS). They are treasury bonds that adjust their interest and principal payments with inflation. TIPS will likely become much more popular with the perceived inflation risk that may loom in the future.
Like other Treasury securities, TIPS pay interest every six months and repay the total principal amount when they mature. The difference is that TIPS’ principal value increases automatically based on the inflation rate as measured by the Consumer Price Index (CPI). So therefore when the CPI rises, the principal value of the TIPS also increases. Interest payments also rise because the interest is calculated on the higher principal amount.
At maturity, TIPS repay the inflation-adjusted principal. Even if prices fall TIPS repay at least the original amount of the bond. If you believe inflation is on the horizon, adding TIPS to your portfolio may help you hedge against it.