More and more economists and investment advisors are warning that inflation may kick up.

How high could it go? And how can you protect yourself, especially if you prize the safety of fixed-income holdings?

Guidance on both questions can be found in the TIPS market. That stands for Treasury Inflation-Protected Securities, a kind of U.S. government bond designed to protect investors from inflation. Many investors have been pouring money into TIPS this spring.

Like all bonds, TIPS pay a fixed interest rate called a “coupon.” But on top of that, a TIPS’ principal value is steadily increased to reflect the inflation rate. The interest earnings are figured every six months by multiplying the coupon rate against the rising principal amount.

Currently, 10-year TIPS carry a coupon rate of about 2.125 percent. If you bought one of these bonds at face value of $1,000 and inflation ran at 2 percent over the next year, the bond’s value would be increased to $1,020. That would be multiplied by the 2.125 percent coupon rate, for earnings of $21.68. Add that to the $20 increase in principal and you’d earn $41.68 for the year, or 4.168 percent.

(Because the calculations are actually done twice a year instead of once, the numbers would be slightly different, but this illustrates the process. For current coupons and yields, check out this table.

Put another way, you would always keep ahead of inflation, in this example earning 2.125 percent above the inflation rate.

Because TIPS are traded between investors in the secondary market, their actual prices usually vary from their original issue price, reflecting changes in supply and demand.

Today, you’d pay slightly more than face value for a 10-year TIPS, so the coupon rate would actually equal a 1.81 percent yield on the price paid. If you kept the bond for 10 years, you’d earn 1.81 percent over the inflation rate. TIPS also come in five and 20-year maturities.

Experts subtract the yields on TIPS from those of ordinary Treasuries to get a sense of investors’ expectations about inflation. With the 10-year Treasury yielding 3.71 percent and TIPS at 1.81 percent, investors appear to expect inflation to run about 1.9 percent. If they thought inflation would be higher, that gap would be wider, and vice versa.

Fixed-income investors like TIPS’ guarantee of above-inflation returns. If inflation were to jump to 4 percent, the TIPS bought today would pay 5.81 percent, while the ordinary Treasury would continue to pay 3.71 percent. (By comparison, five-year certificates of deposit are paying only 2.22 percent, according to the BankingMyWay.com survey.

Despite their benefits, TIPS are not risk-free. To get the inflation adjustments to principal, you must hold the bond to maturity. Sell it earlier and you’ll get a price set by the marketplace. That could be less than you’d paid if newer TIPS are more generous, though it also could be more.

Since you don’t get the principal adjustments until the bond matures, TIPS don’t supply as much annual income as ordinary bonds do. The principal adjustments, as well as the coupon payments, are taxed as income every year.

To avoid annual tax on principal increases that aren’t yet money in your pocket, consider investing in TIPs through a tax-deferred account like an IRA or 401(k). Use the Savings, Taxes, and Inflation calculator to get a sense of your potential earnings.

You can buy TIPS directly from the government at the TreasuryDirect web site, which has lot’s of information on how TIPS work. Take a look at the table comparing TIPS to inflation-indexed U.S. Savings Bonds.

Many investors prefer mutual funds that own TIPS. Morningstar Inc. (Stock Quote: MORN) as a list of good funds and a clear analysis of their recent performance.

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