Investment Bonds Tips And Tricks: Tips On TIPS (Treasury Inflation-Protected Securities) Bonds
Tips on TIPS
Most people today are looking for investments that are guaranteed. After the debacle with our economy in the past few years, no one wants to see their savings wiped out or their investments plummet.
So what's an investor to do?
Especially if you're a person of mature years and limited income, you definitely want to "play it safe" though that phrase and investing seems a bit of a conundrum to me!
Nonetheless, the Federal Treasury has a program for you called Treasury Inflation-Protected Securities which actually might put the word safe back in investments.
Let's examine it and see if it sounds like something that might be worth investing in.
From my perspective, hopefully the Federal Treasury will still be open and running for years to come and could be one of the more sound investments left in the short term.
Tips on Treasury Inflation-Protected Securities (TIPS)
What is TIPS? TIPS is an acronym for the Federal Treasury's investment program called Treasury Inflation-Protected Securities (TIPS).
How does it work? The TIPS program is an investment program wherein you buy bonds issued by the US government. This program is considered extremely safe and your bonds are guaranteed at maturity to NEVER be worth less than their face value.
They also pay an annual dividend somewhere around 2% of the principal. The principal is adjusted for inflation.
How is inflation measured? By the Consumer Price Index so if inflation continues to rise, so does your principal....and you are paid 2% roughly on that inflated amount.
How much can you invest? You can buy TIPS in $100 aliquots. That means that each bond you purchase has a face value of $100. You can invest in them for 5, 10 or 20 years.
Whatever interest rate you buy at will remain in place for the duration of the investment. BUT, the principal goes up every time the cost of inflation goes up.
The example the Federal Treasury gives is this.....You purchase $1000 in TIPS at an interest rate of 2% and a 10 year term. If inflation never went up in that 10-year period, you'd earn $200 on your investment. That's if inflation never goes up. What are the chances of that?
If prices doubled over 10 years though, you would see your principal go up and you'd get an increase in your dividends but the kicker is that your investment would be $2000 at payout.
Okay.....so I'm thinking I might want to check it out and buy. How do I buy TIPS? There are 2 ways to invest in TIPS. You can buy directly from the US Treasury or you can buy through mutual fund brokers by way of an ETF (Exchange Traded Fund).
What's the difference in purchase plans?
There are no transaction fees or charges if you buy through the
government. You receive payments on your
dividends every 6 months but you are responsible for taxes which are paid on the increases in principal (even though you won't see that money until
payout). BUT if you keep your TIPS in a Roth or other retirement account, then you aren't liable for paying tax each year. TIPS are also not subject to any state of local taxes.
If you buy your TIPS through an ETF, you normally receive pay outs of dividends monthly not only on the interest but also on the gains in principal....so what you see is what you get. You still have to pay taxes but you have the money in hand. You can also reinvest money into more TIPS from your dividends if you want to which you cannot do if you buy through the government.
How to Buy TIPS
You can buy TIPS through the Treasury Direct Program. Here is a list of their bonds and when they are put up for auction.
- 5-year TIPS go on auction in April and October
- 10-year TIPS go on auction in January, April, July and October
- 20-year TIPS go on auction in January and July
- These TIPS are sold in increments of $1000 or multiples thereof
You can buy TIPS through investment bankers, brokers or other investment personnel any time throughout the year and they have plans available that are part of mutual funds so that there is no increment that you have to buy at. This is called buying in the secondary market.
You can purchase and reinvest at will but the bonds will still have a maturity date that you must achieve before you'll see your maximum return.
Remember though.....TIPS can never be worth LESS than their face value and you will continue to make money either monthly or twice yearly. Or the mutual funds may be managed so that the dividends stay where they are until maturity such as tax-deferred or Roth accounts.
Tips on TIPS
In summary, this is one investment idea that seems pretty cut and dried.
It also seems very low risk unless of course the government goes belly up and runs out of money entirely, which my mother swears will happen. (see graph below)
The nice thing about a TIPS investment is that no matter what happens with the market or the economy, at least your investment will be at the very least worth FACE VALUE. That to me is a sound investment.
Especially if you're looking at short term investing because of age or upcoming retirement, you want investments that will not lose value in a short period of time and these will definitely keep their value.
If you have more information to share with us on investing in general or particularly on government issued bonds, please enhance my hub by leaving your comments!
Top Foreign Holders of US Treasuries as of September 2010
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