INFLATION-LINKED BONDS

Inflation-Linked Bonds and How They Work for U.S. Investors

Inflation-linked bonds are designed to help investors manage the effects of rising prices. Learn how these bonds work, how inflation adjustments affect returns, and what U.S. investors should consider before adding them to a portfolio.

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INFLATION LINKED
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Inflation-linked bonds and inflation protection for U.S. investors
UNDERSTANDING INFLATION-LINKED BONDS

What are inflation-linked bonds?

Inflation-linked bonds are debt investments whose principal, interest payments, or both can be adjusted according to changes in an inflation measure. Their purpose is to help reduce the impact that rising prices can have on the purchasing power of an investor's money.

For U.S. investors, the best-known example is the Treasury Inflation- Protected Security, commonly called TIPS. TIPS are issued by the U.S. Treasury and are designed so that their principal value adjusts with changes in the Consumer Price Index for Urban Consumers, or CPI-U.

Because the mechanics differ from ordinary fixed-rate bonds, investors should understand how inflation adjustments affect both the bond's value and its potential income.

Why inflation matters

When prices rise, the same amount of money generally buys fewer goods and services. Inflation-linked bonds are structured with that purchasing-power challenge in mind.

HOW THEY WORK

The key difference is the inflation adjustment.

Traditional bonds generally have a fixed principal amount. Inflation- linked securities can use an inflation index to adjust their principal, changing the amount on which interest may be calculated.

01

Bond Is Issued

An issuer sells the bond to investors and establishes its maturity, interest rate and other terms.

02

Inflation Is Measured

The applicable inflation index is used to determine changes in the bond's inflation-adjusted principal.

03

Principal Adjusts

Depending on the security, the principal can increase or decrease based on changes in the applicable inflation measure.

04

Interest Is Calculated

Interest payments are based on the terms of the security and, for inflation-adjusted principal structures, may change as principal changes.

U.S. INVESTOR FOCUS

TIPS are one of the best-known inflation-linked investments.

Treasury Inflation-Protected Securities are issued by the U.S. Treasury and are designed to provide protection against inflation through adjustments to principal based on changes in CPI-U.

TIPS are available with different maturities and can be purchased through TreasuryDirect or through brokerage accounts. They can also be accessed indirectly through certain mutual funds and ETFs.

The fact that a bond is inflation-linked does not mean that its market price will always rise when inflation rises. Market interest rates, expectations about future inflation, maturity and demand can all affect market prices.

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INFLATION AND FIXED INCOME

Inflation can change how bond returns feel in real terms.

A bond may provide a stated interest rate, but investors also need to think about what those payments can purchase in the future.

For example, if an investment earns a return that is lower than the rate at which prices rise, the investor's purchasing power may decline even though the account balance has increased.

Purchasing power
Inflation expectations
Real returns
POTENTIAL BENEFITS

Why investors may consider inflation-linked bonds.

Inflation-linked securities can serve a specific role within a broader fixed-income strategy, particularly when purchasing-power risk is an important consideration.

Inflation Protection

Certain inflation-linked securities are structured so their principal responds to changes in an inflation index.

Portfolio Diversification

Inflation-linked bonds can provide a different source of fixed-income exposure compared with conventional nominal bonds.

Long-Term Planning

Their inflation-linked structure may be useful when an investor is focused on maintaining purchasing power over a longer horizon.

RISKS TO UNDERSTAND

Inflation-linked does not mean risk-free.

These securities can still experience price changes and other risks. Understanding the structure is important before investing.

01

Interest-Rate Risk

Changes in market interest rates can affect the market price of bonds when they are sold before maturity.

02

Deflation Risk

Inflation-linked principal adjustments can move in the opposite direction when the applicable inflation measure declines.

03

Market Price Risk

A bond's market price can fluctuate because of changing rates, inflation expectations and investor demand.

04

Inflation Measurement

The inflation protection provided by a security depends on the specific index and adjustment methodology used.

05

Reinvestment Risk

Future interest or principal payments may need to be reinvested at rates that are different from the original investment.

06

Tax Considerations

The tax treatment of inflation-linked securities can depend on the specific investment and the investor's circumstances.

COMPARING BONDS

Inflation-linked bonds vs traditional bonds.

Both are fixed-income investments, but their relationship with inflation can be different.

Factor
Traditional Bonds
Inflation-Linked Bonds
Principal
Generally fixed according to bond terms
May adjust based on an inflation index
Inflation Exposure
Generally no direct inflation adjustment
Designed to respond to specified inflation measures
Interest Payments
Usually based on stated coupon and principal
May change when inflation-adjusted principal changes
Primary Consideration
Rates, credit and maturity
Inflation, rates, credit and maturity
Purchasing Power
Can be affected by unexpected inflation
Structure is designed to address inflation exposure
BEFORE YOU INVEST

Questions to ask before buying an inflation-linked bond.

Understanding the security's structure can help you decide whether it fits your broader investment strategy.

01

Which inflation index is used?

Check exactly which measure determines the inflation adjustment.

02

Who is the issuer?

Review the issuer's credit quality and ability to meet its obligations.

03

What is the maturity?

Consider whether the maturity fits your financial timeline and goals.

04

What is the real yield?

Compare the potential return after considering inflation expectations.

05

Can you sell before maturity?

Understand how market prices may change if you need to sell early.

06

What costs apply?

Review commissions, spreads, fund expenses or other applicable costs.

REAL RETURNS MATTER

Focus on what your money can buy in the future.

Looking only at the stated return of an investment can leave out an important part of the picture. Inflation affects the purchasing power of future income and principal.

Inflation-linked bonds are designed around this issue. For investors who are concerned about rising prices, they can provide a useful comparison point alongside conventional bonds and other fixed-income investments.

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Frequently asked questions about inflation-linked bonds
FREQUENTLY ASKED QUESTIONS

Questions about inflation-linked bonds.

Inflation-linked bonds are debt securities whose principal, interest payments, or both can be adjusted according to changes in a specified inflation measure.

Treasury Inflation-Protected Securities, or TIPS, are bonds issued by the U.S. Treasury that are designed to provide inflation protection through adjustments to principal based on changes in CPI-U.

The principal of TIPS is adjusted based on changes in the applicable inflation measure. Because interest is calculated using the adjusted principal, the interest payment can also change.

No. Inflation-linked bonds can still experience interest-rate, market-price, reinvestment and other risks. Their inflation adjustment does not eliminate investment risk.

Yes. Their market prices can decline, particularly when market interest rates rise or investor expectations change. Selling before maturity can result in a gain or loss.

They can provide a different type of fixed-income exposure and may complement other bonds in a diversified portfolio, depending on an investor's goals, time horizon and risk tolerance.

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