In an economy where the US dollar is slipping away further than the balloon in the Balloon Boy story, it’s time to consider investment options that account for inflation. Familiar with TIPS? We’re not referring to tips in the context of tipping a server (although that’s a necessary evil). We’re talking about TIPS, an acronym for Treasury Inflation Protected Securities.
What are they?
They’re a specific kind of Treasury note or bond that protects one from inflation. Like other Treasuries, the inflation-indexed security pays interest every six months and renders the principal upon the security maturity date. The beauty in these is that the payments and underlying principal are automatically increased to compensate for inflation as measured by the consumer price index (CPI).
Investopedia adds this about TIPS:
If U.S. Treasuries are the world’s safest investments, then you might say that TIPS are the safest of the safe. This is because your real rate of return, which represents the growth of your purchasing power, is guaranteed. The downside is that, because of this safety, TIPS offer a low return.
Further information from Ehow on how and where to buy TIPS:
Plan your investment
TIPS are sold in increments of $100 (the face value) and have a term of either 5, 10, or 20 years. The interest rate you’ll earn is determined at the time of purchase and is fixed throughout the lifetime of the security. The principal value of your TIPS, however, is adjusted every time the CPI changes. Say, for example, you purchase $1000 inTIPS at an interest rate of 2% and a term of ten years. If inflation never changed throughout the ten year period, you’d make a flat $200 over the life of your TIPS. Not very impressive. But say that prices double over the ten year term. In this case, you’d not only see a modest increase in your dividend payments, but your principal would be worth $2000 at maturity.
There are two ways to purchase TIPS. You can either buy them directly from the US Treasury or through a type of mutual fund called and Exchange Traded Fund (ETF). If you buy from the Treasury, there are no transaction fees, but you’ll only receive your dividend payments every six months. You’ll also be required to pay taxes on the increases in principal even though you won’t actually receive that money until the TIPS mature. On the other hand, if you buy TIPS through an ETF, you’ll typically receive monthly payouts of not only the interest, but also the gains in principal. You’ll still have to pay taxes, but at least you’re getting the money up front. You’ll also be able to automatically reinvest your dividends in additional TIPS, an option not available with direct purchases. For more details on buying TIPS, see the link, in the Resource Section.
*Image courtesy of Good as Goeldi.
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