Inflation-Linked Investing

Traditional bonds pay a fixed rate of interest over the life of the investment. Inflation-linked investments pay interest based upon changes in the Consumer Price Index (CPI) for all Urban Consumers1, in addition to a fixed coupon rate, and therefore, provide a consistent and predictable real return. There are several types of inflation-linked structures that provide protection from the negative effects of inflation:

“Adjusted Principal” Structure
Inflation-linked investments with an “adjusted principal” structure provide inflation-linked returns by increasing the base amount of the investment to keep pace with changes in CPI, while also paying semiannual coupon interest as a percentage of that adjusted base. At maturity, the inflation adjustment amount that has been accumulating during the holding period is paid out along with the original investment amount. This ensures that the money you get back at maturity will have the same “buying power” that your initial investment did when you bought it. With the effects of inflation neatly taken care of in this manner, it's easy to see that the coupon payments received represent the real return on the investment. Certificates of Deposit: Inflation-Protected (CDIPs) and the U.S. Treasury’s TIPS product are issued using the adjusted principal structure.

“Floating Coupon” Structure
Inflation-linked investments with a "floating coupon" structure pay a monthly coupon that changes, or “floats” periodically, based on the change in CPI over the previous year. Instead of adding the inflation component of the return to the principal balance, this type of investment simply pays it out as part of each coupon payment. At maturity, the initial investment is returned to the investor without any inflation adjustment. Therefore, a portion of each interest payment is meant to offset inflation, and the remainder is the real return. Inflation-Floater Certificates of Deposit (IFCDs) and inflation-linked corporate notes are issued using the floating coupon structure.

Which Inflation-linked Investment to Choose?

  Adjusted Principal Structure Floating coupon Structure
Automatic principal adjustment reduces reinvestment risk but taxation may be a problem if tax-advantaged funds are not available.
Monthly payments are more trouble to reinvest, but tax benefits may outweigh the inconvenience and risk.
Payment structure ideally suited to preserve long-term income producing power of savings while providing inflation-indexed income.
Real value of savings will diminish if a portion of each interest payment is not reinvested. Requires discipline to manage this effectively.
Diversified Investor
Either structure provides diversification benefits. Tax consequences should be the main consideration.

1 Additional information about the Consumer Price Index can be found at


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