If the CPI-U decreases, your principal will decrease, so that your interest payments will also decrease over time. However, when the bond matures, you still receive the full principal value.

From a tax standpoint, interest income is subject to federal income taxes, but not state or local income taxes. Also, any increases in the bond's principal value is subject to federal income taxes in the year the adjustment is made, even though the funds aren't received until the bond matures. However, if the TIPS is held in a tax-advantaged account, such as a 401(k) plan or individual retirement account, income taxes are not paid until the funds are withdrawn.

To decide whether TIPS are a better alternative than other Treasury securities, calculate the difference between the yield on a 10-year TIPS and a 10-year Treasury security. As of May 27, 2008, that difference was 2.49% (Source: Federal Reserve Statistical Release), which is considered the breakeven rate. If inflation is higher than 2.49% over the 10-year period, the TIPS will have a higher yield than other Treasury securities. However, if inflation is lower than 2.49% over the 10-year period, the other Treasury security will have a higher yield than the TIPS.

With current inflation rates running around 3.8%, you might think that a TIPS is the better alternative. However, it is difficult to predict inflation over long time periods, so future inflation could be lower.