One of the most basic tenets of investing is that U.S. Treasury bonds are some of the safest investments one can make. They’re backed by the federal government, and they are practically guaranteed not to lose value. But when inflation rises, they can’t always keep up, and that means you could still come out behind in terms of buying power.
Treasury Inflation-Protected Securities, or TIPS for short, offer a solution to this dilemma. They are Treasury notes and bonds as well, but the principal and interest are indexed to the inflation rate. In effect, they’re inflation-proof. But that doesn’t mean they’re fool-proof.
Here is some investing advice to consider if you’re thinking about buying TIPS.
You won’t get rich by investing in TIPS. They should only be used as a low-risk component to a diversified portfolio. Interest is significantly lower than the returns for most other investments, and while it’s unusual to lose money with TIPS, the only way you’ll see large gains is if there is an unusual amount of deflation after the investment term is up.
If deflation occurs during the bond’s term, the benefit of investing in TIPS will be reduced or eliminated. Think opportunity costs – if you hadn’t had your money tied up in TIPS, it could have been earning more interest elsewhere. However, investors are guaranteed 100% of their principal, so at least you won’t be losing the money you put into them.
TIPS are long-term investments. They are usually sold with 5-, 10- or 20-year maturity dates.
TIPS may be purchased directly from the government, which sells them at auction. You may submit a competitive bid, which allows you to specify the yield you will accept, or a noncompetitive bid, which guarantees that you’ll get the number of shares you want but requires you to accept the yield that is determined at auction. Competitive bids must be placed through a broker, bank or dealer, but you can submit noncompetitive bids directly.
You may also purchase bond funds that match the performance of TIPS. This allows for professional management and makes things easier if you decide to sell.
Interest payments and inflation adjustments are considered taxable income for federal income tax purposes. For this reason, it is recommended that you keep TIPS in a tax-deferred or tax-free account.
TIPS are a generally sound investment. But it’s best to purchase them at a time when inflation is expected to rise in order to get the most out of them. Since the idea with tips is to simply stay ahead of inflation, they make a good low-risk investment to add to your portfolio. They won’t make you a millionaire, but they will keep a portion of your money nice and safe and ensure that it doesn’t shrink due to inflation.
Tags: inflation, investing advice, TIPS
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on Wednesday, September 7th, 2011 at 7:47 am and is filed under Bonds.
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One of the most basic tenets of investing is that U.S. Treasury bonds are some of the safest investments one can make. They’re backed by the federal government, and they are practically guaranteed not to lose value. But when inflation rises, they can’t always keep up, and that means you could still come out behind in terms of buying power.
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