Al Gore and TIPS
Question: Hello, I have never purchased a bond and wanted to look into the inflation-protected bonds discussed in the 10-26-10 story. I went to the Dept. of Treasury’s website and tried to fine the bond and got a VP Al Gore story. Question is, are these bonds available for sale to an individual and what is their particular name so I know I’m looking at the right one? Thanks, Valerie, Luray, VA
Answer: Al Gore, huh? Did he invent inflation protected bonds? That he turned up puzzled me, so I did a little digging. The idea of a fixed-income security whose value cannot be eroded by inflation had been around for a long time. Economists had been clamoring for years that the U.S. government start issuing them. After all, Israel, Canada, Sweden, New Zealand, Britain, and a number of other countries had sold them for years. In 1997 the U.S. government joined the club. It’s version is called Treasury Inflation Protection Securities, but they are better known as TIPS. Vice President Al Gore announced the creation of TIPS in early January, 1997. Mystery solved.
The story you’re referring to is here. It was a stunning moment when investors for the first time bought TIPS at a so-called “negative yield.” That means the buyers paid more for the bonds that they were worth. The owners of the TIPS started out at a loss on their investment. The reason they were willing to do that is the belief that inflation will run hot enough and high enough that the value of the bonds will rise over time. In that case, investors will be more than compensated for the short-term (paper) loss.
By design, TIPS protect the value of an investment dollar over time. The security is the long-term savers’ friend. One of the biggest risks faced by savers is that inflation will erode the value of money. Inflation-indexed bonds come in 5, 10 and 30 year maturities. The minimum purchase is $100. TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. An additional advantage of TIPS is that they protect against deflation–a decline in the overall price level of goods and services–by offering a “deflation floor” that protects principal value during deflation. Default risk is nonexistent, since these are obligation of the U.S. government.
TIPS have two main drawbacks. The first is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on your inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. The other issue is that for a variety of legal and regulatory reasons you can’t buy TIPS directly from the U.S. Treasury for your retirement savings account. (You can buy them directly from the Treasury for a taxable account.) You have to pay a broker to do it for you.
One other point: Taxes aren’t an issue with I-Savings Bonds, the federal government’s other inflation-protected security. These 30-year bonds allow money to compound tax-deferred until they are cashed in. There are no commission costs when buying or selling them. I-bonds redeemed before the 5 year mark forfeit the 3 most recent months’ interest, but after 5 years that there is no penalty at redemption. The only drawback to I bonds is that you can’t buy very much at a time. Savers can purchase $10,000 worth a year–$5,000 online from the Treasury and $5,000 in paper bonds bought at a bank. You can learn all about I-bonds and buy them too at Treasurydirect.gov.
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