Treasury-Inflation Protected Securities (TIPS) How they work: TIPS protect against inflation through their connection to the Consumer Price Index. Specifically, TIPS' principal rises with inflation and falls during deflation. If someone buys $100,000 in TIPS and inflation increases by 3 percent, the TIPS principal will be worth $103,000 by the end of the year. (Adjustments are made every six months.) When TIPS mature, investors receive the original principal amount or one that's been adjusted, whichever is greater. TIPS pay interest every six months. This interest rate is constant, but the earnings fluctuate because they're based on the inflation-adjusted principal.
Who they're good for: Retirees, and anyone else living on a fixed income.
Cost: TIPS are sold directly from the U.S. Treasury Department in increments of $100. You also can purchase shares of mutual funds that primarily invest in TIPS, such as Harbor Real Return or Vanguard Inflation-Protected Securities.
Liquidity: TIPS are very liquid. You can sell them at any point in time, though there's no guarantee you'll make money: If you sell before the TIPS maturity date you incur a risk of selling at a premium or discount of what you've paid for it.
Pros: Inflation protection.
Cons: Taxes. Investors must pay ordinary income tax rates, which can be as high as 35 percent, for the interest they receive as well as for any increase in value in the TIPS principal. Experts recommend that TIPS be held in tax-sheltered accounts such as a 401(k) or an IRA.
Risk: The value of the principal can go down, so if you sell prior to maturity, you may get less than what you paid.
I bonds How they work: I bonds are designed to keep pace with rising prices by paying a composite interest rate that's made up of two parts: an underlying fixed rate and an inflation-adjusted variable rate. The variable interest portion is tied to the CPI rate and rises and falls during the life of the bond to keep pace with prices. The fixed rate portion remains unchanged for the life of the I bond. This rate changes semiannually, on May 1 and Nov. 1, for newly issued bonds. Currently, I bonds are paying a composite rate of 5.64 percent. On Nov. 1, the underlying fixed rate was set at 0.70 percent, and the semiannual inflation rate was set at 4.92 percent. These rates will change again on May 1.
Who they're good for: Retirees who already have a hefty nest egg and therefore don't need as much growth should look to I bonds.
Cost: I bonds can be purchased electronically in amounts of $25 or more, or for a minimum $50 for paper versions, from Uncle Sam at TreasuryDirect.