Transparent method
The formula
Worked example
Example inputs
How to interpret the result
Treasury inflation-protected securities adjust their principal for inflation, and the coupon is paid on the adjusted principal. A $10,000 TIPS held ten years at 2.5 percent average inflation grows to about $12,801, an adjustment of $2,801, and a 1.5 percent real coupon in the last year pays about $192. The real coupon stays fixed while the dollar amount rises, so the income keeps pace with prices, and the adjustment is taxed in the year it accrues in a taxable account.
Before you rely on it
What to check
Compare the real yield on a TIPS with the yield on a regular Treasury of the same term. The gap is the inflation the market expects.
The common error
Where people go wrong with TIPS inflation adjustment calculator
Assuming TIPS cannot lose money. If inflation is low or prices fall, the principal adjustment is small, and the market price moves with real interest rates.
Sensitivity evidence
How original TIPS principal changes the inflation-adjusted principal
| Original TIPS principal | Inflation-adjusted principal | Final-year annual coupon | Principal inflation adjustment |
|---|---|---|---|
| $8,000 | $10,241 | $154 | $2,241 |
| $9,000 | $11,521 | $173 | $2,521 |
| $10,000worked example | $12,801 | $192 | $2,801 |
| $11,000 | $14,081 | $211 | $3,081 |
| $12,000 | $15,361 | $230 | $3,361 |
Every input, tested
Which input moves the inflation-adjusted principal most
| Input | Tested from | To | Inflation-adjusted principal at each end | Swing |
|---|---|---|---|---|
| Original TIPS principal | $9,000 | $11,000 | $11,521 to $14,081 | $2,560 (20%) |
| Average annual inflation | 1.5% | 3.5% | $11,605 to $14,106 | $2,501 (20%) |
| Years held | 7.0 years | 13.0 years | $11,887 to $13,785 | $1,898 (15%) |
| Real coupon rate | 1.3% | 1.8% | $12,801 to $12,801 | none |
Two variables at once
Inflation-adjusted principal by original TIPS principal and average annual inflation
| Original TIPS principal \ Average annual inflation | 0.500% | 2.5% | 4.5% |
|---|---|---|---|
| $8,000 | $8,409 | $10,241 | $12,424 |
| $9,000 | $9,460 | $11,521 | $13,977 |
| $10,000 | $10,511 | $12,801 | $15,530 |
| $11,000 | $11,563 | $14,081 | $17,083 |
| $12,000 | $12,614 | $15,361 | $18,636 |
Step by step
The worked example, input by input
| Input | Value used |
|---|---|
| Original TIPS principal | $10,000 |
| Real coupon rate | 1.5% |
| Average annual inflation | 2.5% |
| Years held | 10.0 years |
| Inflation-adjusted principal | $12,801 |
| Final-year annual coupon | $192 |
| Principal inflation adjustment | $2,801 |
Where the inputs come from
Original TIPS principal is the face value you buy, the real coupon rate is the fixed rate stated on the bond, which is applied to the inflation-adjusted principal, average annual inflation is your assumption for the change in the Consumer Price Index over the holding period, and years held is the time. Actual adjustments follow the CPI-U with a lag of about two months, and the principal cannot fall below the original amount at maturity. Real yields are set at auction.
Using the inflation-adjusted principal in a real decision
Use them for the part of a portfolio that must keep up with prices.
When the result stops applying
In a taxable account you owe tax each year on the inflation adjustment even though you receive it only at maturity, so TIPS are often held in tax-deferred accounts. Deflation can reduce the principal, though not below par at maturity. TIPS prices fall when real yields rise. The real yield may be low, and the CPI may differ from your own inflation.
What to compare it with
Compare with nominal yields on the real yield calculator, and project prices on the inflation calculator. The bond duration and yield to maturity pages show rate risk, and the zero-coupon and bond ladder pages cover other structures. I bonds are another inflation-linked option with purchase limits.
People also ask
Frequently asked questions
How do TIPS protect against inflation?
Their principal is adjusted for changes in the Consumer Price Index, and the coupon is paid on the adjusted principal, so both income and value rise with inflation.
What is breakeven inflation?
The inflation rate at which TIPS and a nominal Treasury of the same maturity give the same return. If inflation is higher, TIPS win.
Are TIPS taxed on the inflation adjustment?
Yes, in a taxable account the increase in principal is taxed each year as income, even though you do not receive it until maturity, which is why many hold TIPS in IRAs.