THE COLOR OF MONEY
Treasury offers securities for inflation-leery investors
By Michelle Singletary
WASHINGTON — The first time I sat down with my financial planner, she asked me to describe my "risk tolerance."
For those not familiar with that phase, it means: How comfortable are you with the possibility of losing any or all of your money if you choose certain investment options?
For example, junk bonds are highly risky. If you decide to invest in them, you should have a high tolerance for risk. On the other end of the risk scale is the ultra-safe U.S. savings bond.
Where do I fall on the risk scale?
I'm the kind of person who thinks twice about putting a quarter in a gumball machine because my gumball might not drop and I would lose my quarter.
When it comes to my investments, I'm happy if I can protect my principal and guard against inflation.
It's risk-averse, inflation-worried investors like me who might be interested in two inflation-indexed securities offered by the U.S. Treasury — the Treasury Inflation-Protected Securities (TIPS) and I Bonds.
Both are designed for investors who want a guaranteed rate of return on their principal, and inflation protection.
With TIPS, introduced in 1997, the principal amount invested is adjusted for inflation using the Consumer Price Index (CPI). Interest is paid semiannually and is calculated using the adjusted principal amount.
Like other notes and bonds, TIPS pay a fixed rate of interest. But this fixed rate of interest is applied to the inflation-adjusted principal. So, if inflation occurs throughout the life of your security, every interest payment will be greater than the previous one. However, in the event of deflation your interest payments will decrease (deflation is a decline in overall prices). Yet even if there is a period of deflation, you are guaranteed a return of your original principal.
"With TIPS you have a lot of protection against rising inflation and interest rates, which you don't have in a normal bond, and that's the scary thing about just locking in normal bonds right now with (interest) rates so low," said Michael W. Boone, a certified financial planner from Bellevue, Wash. "Also, TIPS are extremely liquid. They are very easy to buy and sell. But you get whatever the market price is, so you may get more or less than what you put in if you sell them before maturity."
You have three opportunities every year to buy TIPS directly from the Treasury. You can buy them in July, October and January in multiples of $1,000. The only maturity available is 10 years. You can buy TIPS at any time in the secondary market. Right now 10-year TIPS issued last July are yielding about 2.16 percent. Ten-year securities purchased directly from the Treasury in July 2002 pay 3 percent.
TIPS are exempt from state and local income taxes but they are subject to federal income tax. You will have to pay taxes on any gains on the interest earned and the inflation-adjusted principal amount. You can avoid paying the taxes each year if you hold TIPS in a tax-deferred account such as an Individual Retirement Account.
For more details about TIPS or purchasing information, go to www.treasurydirect.gov.
The second type of inflation-protected Treasury security is the Series I inflation-indexed savings bond, which was introduced in 1998. The I Bond is an accrual-type security — meaning interest is added to the bond monthly and paid when the bond is cashed. The bonds are sold at face value so you pay $100 for a $100 bond.
The earnings rate is a combination of a fixed interest rate plus the rate of inflation, adjusted semiannually. The fixed rate remains the same throughout the life of the bond, while the semiannual inflation rate can vary every six months. Both the fixed rate of return and the semiannual inflation rate are announced by the Treasury Department each May and November. The rate for the I Bond through April was 4.08 percent.
You can buy I Bonds from most banks, credit unions and savings institutions, or over the Internet at www.savingsbonds.gov. You can invest as little as $50 or as much as $30,000 a year. With an I Bond you can defer federal taxes on earnings for up to 30 years. The bonds are also exempt from state and local income taxes.
Clearly, you won't get rich putting your money in TIPS or I Bonds.
But if losing even a quarter bothers you, these two investment options will keep your money safe and sound.
