An unpredictable market, rising fuel prices, and growing concern that inflation may trend higher as the economic recovery takes hold.

These are three good reasons to add inflation protection to your portfolio, says Mario DeRose, fixed income strategist with Edward Jones in New York.

“There’s always a place in a portfolio to hedge against inflation, even in periods when inflation seems unlikely in the near term,” says DeRose, noting that shocks in the market can cause consumer prices to spike without warning. “You have to be on guard.”

Enter: Treasury Inflation-Protected Securities, or TIPS.

TIPS are government bonds issued by the U.S. Treasury in maturities that range from five to 30 years.

Unlike conventional bonds, TIPS pay out a guaranteed “real” return; the principal is adjusted for inflation based on the Consumer Price Index, CPI, and semi-annual interest payments (the yield) are modified accordingly.

At maturity, investors receive either the inflation-adjusted principal or par value, face value, of the bond, whichever is greater.

As such, TIPS are used to hedge inflation, helping investors maintain purchasing power when the price of goods and services climbs, with the added benefit of providing downside protection during periods of deflation .

Such securities have served investors well over the last few years, as falling interest rates push bond prices higher.

The Barclays Treasury Inflation Protected Securities index, for example, produced a total return (which consists of the bond’s income distributions plus any appreciation or depreciation in the price of the bond itself) of 13.6 percent in 2011, 6.3 percent the year before, and 11.4 percent in 2009. It is up roughly 2.5 percent this year.

The total return for the SPDR DB International Government Inflation-Protected Bond ETF, is also up roughly 8 percent year-to-date.

By comparison, conventional 10-year Treasury bonds returned 17 percent last year and 8.1 percent in 2010, on the heels of a nearly 10 percent loss in 2009.

Negative Yields

Due to demand from wary investors, however, the yield on TIPS is in negative territory; for 10-year TIPS the interest payments are hovering at negative 0.4 percent.

Those buying today are willing to accept a negative yield because they believe inflation is likely to rise enough to compensate for the loss they’re locking in and because they seek the safe haven that government backed bonds provide, says Christine Benz, director of personal finance for fund tracker Morningstar.