Both TIPS and I Bonds offer inflation protection. How are they different? In a nutshell, TIPS work like a bond, while I Bonds work like a CD.
Like all bonds, after TIPS are issued, they are traded on the secondary market. Every day, the buyers and sellers on the market determine the price and yield of each TIPS bond, which will be different from the price and yield when the bond was originally issued. TIPS prices fluctuate, both up and down, depending on the market. However, because there is an active market, the price and yield are considered to be fair at any time.
I Bonds on the other hand don't trade on the secondary market. They earn a variable interest rate. Their values only go up or stay the same, never go down. If the base rate on newer I Bonds goes down, your existing I Bonds do not get a boost in principal value like TIPS would. They only earn a higher interest rate than the newer I Bonds. If you have those high base rate I Bonds, the best you can do is hold them until they mature. You cannot realize a capital gain from your I Bonds as you would from TIPS. Essentially you lose liquidity from your older, better I Bonds.
On the other hand, if the base interest rate on newer I Bonds goes up, you can redeem your lower rate I Bonds without suffering a capital loss like you would from TIPS. This feature on I Bonds is called a built-in put option. Because of this put option, and because the base rate on I Bonds is set arbitrarily by the I Bond issuer, the U.S. Treasury, the interest rate on I Bonds can be a lot lower than TIPS, whose price and yield are set by the market. I Bond yields cannot be considered as fair. I Bonds purchasers often pay dearly for the no-loss guarantee.
I Bonds are easier to buy in smaller quantities. The lowest I Bonds purchase starts at $25. For large purchases though, investors can buy practically as much TIPS as they want. U.S. Treasury limits I Bonds purchase to $10,000 per social security number per year: $5,000 max. electronically, $5,000 max. in paper.
TIPS can be bought in an IRA through a brokerage account. I Bonds can only be bought with taxable money, while I Bonds themselves are tax deferred. I Bonds can be bought at any time in the year, without commission. They can be redeemed without commission at any time after 12 months. Buying TIPS without a commission or a markup has to wait for special auctions (conducted only eight times a year). Selling TIPS before they mature always involves a commission and/or a markdown.
TIPS pay out interest. If held in a taxable account, both the interest payment and the inflation adjustment are taxable. I Bonds do not pay out interest. Interest is added to the accrued principal value. The increase in principal value becomes taxable when I Bonds are redeemed. If the I Bonds are used for education purpose and the purchaser meets some other conditions, the interest is tax free. There is no such feature on TIPS.
In general, serious investors prefer TIPS while small savers prefer I Bonds. For serious investors, the higher yield on TIPS year after year pays off for the price fluctuation, the inconvenience of waiting for auctions, or the one-time commission or markup.