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Treasury
securities are devices the US Treasury uses to raise money to pay off its
debts and operate the Federal Government. They are often considered a safe
and secure investment option because they are liquid and easily sold for cash
and because the government guarantees the principal and interest payments
will be made on time.
Now that inflation is beginning to show signs of rising, investors may want
to take a look at inflation-adjusted government bonds - an option easily
ignored during low-inflation times.
Several government issued options such as Treasury Inflation Protected
Securities (TIPS) and Series I savings bonds are available to investors who
are concerned about inflation.
TIPS for Inflation Conscious Investors
The US Treasury auctions new TIPS every three months at a fixed rate and
interest is paid twice a year. Every six months, the
principal value of TIPS is adjusted to reflect inflation, measured by the
Consumer Price Index (CPI).
For example, let's say you invest $20,000 today in TIPS with a fixed interest
rate of 2 percent. During the next six months, inflation rises to 3
percent. The principal value (not the interest rate) is increased to $20,600
(3 percent of $20,000). The 2 percent fixed interest rate from your original
purchase of TIPS is then applied to the principal balance of $20,600 for the
next six month interval rather than to the $20,000 originally invested.
There is no limit to how many TIPS you can buy. Exempt from state and local
tax, the semiannual principal payments from TIPS are subject to federal
income tax even though you don't actually receive the principal increase
amount until the bond matures or until you sell it.
The risk involved with investing in TIPS is that they can actually lose
principal in the event that interest rates rise and you sell the bond before
it matures.
Bonds.I-Bonds
Like TIPS, savings bonds are Treasury securities that are only payable to the
individual registered on the bond. When the Federal Government issues
I-bonds, a minimum fixed rate for that particular issue is announced. That
rate does not change for the life of the bond, which can be up to 30 years.
The government adjusts the rate for newly issued bonds every six months, but
again, that rate remains consistent through the life of the bond.
The major difference between TIPS and I-bonds is that in addition to the
underlying fixed rate, the government adds an inflation-adjusted interest
rate based on the CPI for the previous six month period. Investors can
purchase a maximum of $30,000 in electronic I-bonds and an additional $30,000
in paper I-bonds in any given calendar year. The bonds must be held for
a minimum of 12 months before cashing them in, and if you cash them in within
five years, you lose three months worth of interest.
An investor can't lose principal with I-bonds like they risk with TIPS, but
the fixed rate is less than what you would experience in comparable
non-indexed Treasury bonds. If inflation is actually lower than anticipated,
investors may have done better with regular bonds rather than with these
inflation-adjusted vehicles.
As with any investment, before committing your money, invest your time in
understanding both the risks and how that investment fits in with your
overall financial plan. You can find more information including online
purchasing at www.savingsbonds.gov,
the Treasury Direct website.
Michael Haubrich, CFP, is president of Financial
Service Group, Inc., a registered investment advisory firm in Racine,
WI. Website address www.toyourwealth.com.
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