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TIPs: An Investment Guaranteed to Keep Pace with Inflation-Part 2

By in Bond, Investing | 3 comments

 TIPS-Protect Your Cash From Inflation

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”  Ronald Reagan 

Since we haven’t had much inflation in recent years, it’s easy to forget about it’s violent impact.

One of President Reagan’s (1981-1989) political challenges was combating the rampant inflation of the time. He entered office after record levels of inflation!

Check out what Reagan was talking about. These are the inflation rates from 1975 to 1986: 

YEAR AVERAGE INFLATION
1986   1.91%
 1985   3.55%
  1984   4.30%
 1983   3.22%
 1982   6.16%
 1981   10.35%
  1980   13.58%
 1979   11.22%
 1978   7.62%
 1977   6.50%
 1976   5.75%
 1975   9.20%

Here’s how the sting of inflation plays out; if you bought a video game in 1975 for $47.38, that same game would cost $100.00 in 1985. That’s over a 100% cost increase in 5 years. Don’t get complacent and think that we will never have high inflation again. It’s quite likely, that higher inflation levels will return in the future!

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How to Protect your Money from the Ravages of Inflation

TIPs-the #inflation solution.

The previous post  talked about buying I Bonds as a way to invest and make sure that your investment keeps up with the impact of inflation. Even with 3% inflation per year (the historical average), your $10.00 meal out will cost $13.44 in 10 years. Now, bump inflation up to 5% and watch that $10.00 meal go up to $16.29. Next, apply those inflation increases to everything you buy. Don’t think you will avoid inflation in the future.

Here’s another investment which keeps up with inflation and is also issued by the government; Treasury Inflation Protected Securities. They have the same goal as Series I Savings Bonds, to protect your cash from inflation risk, so when you need it in the future, the purchasing power hasn’t been eroded.

 TIPs are bond-like investments issued by the US government. They have a fixed interest rate… but they keep up with inflation because when inflation rises, the principal amount of the security (bond) also increases. On the flip side, when inflation drops, so does the principal amount of the bond. At the treasurydirect.gov website there is lots of information about TIPS.

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What are Treasury Inflation Protected Securities (TIPS)?

Government Bonds 101

Buy a government bond and you are making a loan to the U.S. Government.

In exchange for the loan, the government pays you interest.

  How does the TIPS investment work?

 With TIPS, the interest rate is set at the purchase date. It always stays the same.

BUT-the PRINCIPAL value of the investment goes up and down with the inflation rate.

AND when the principal increases (decreases) you will get a LARGER (smaller) interest payment on the new principal amount. 

When the TIPS security matures, you get the higher or original principal amount; At maturity, you never get a smaller principal.

Facts About TIPS:

You can buy them on-line at Treasury Direct.gov. They can be purchased in increments of $100.00.

TIPS have maturities of 5, 10 and 30 years.

You can hold TIPS until maturity or you can sell the securities in the open market through an investment brokerage company like Charles Schwab, E*TRADE, Fidelity, Vanguard, or TD Ameritrade.

They are subject to federal tax only, not state or local. You pay the tax in the year it is earned.

The Easiest Way to Buy TIPS:

There are several mutual funds which hold many TIPS in various maturities. It is really easy to buy them, through one of the discount brokerage companies listed above. Currently, with rock bottom interest rates are calling into question the viability of owning TIPS. But, when interest rates begin to rise, you’ll be glad to know about this handy government bond offering.

How do I Bonds & TIPS compare?

  TIPS I BONDS
Type of Investment Marketable-can be bought & sold thought investment companies. Can buy TIPS mutual funds. Non-marketable. Bought through treasurydirect site, bank or some employers
Face Amount (PAR) Minimum $100 for individual TIPS. Funds set by investment companies. $25.00 or more, up to $5,000/year.
Interest Set semiannually-paid on adjusted principal Interest is accrued over life of bond & paid upon redemption
Lifespan TIPS mutual funds can be held indefinitely. Individual TIPS can be held to maturity (5, 10, or 30 years) or sold prior in the secondary market. Redeemable after 12 months (with 3 months interest penalty). No penalty after 5 years. Earn interest up to 30 years.

RISK is always a factor in investing.

 Inflation risk manifests insidiously by causing the same dollar to purchase less and less product(s).  Another way to look at inflation is; the identical goods cost more and more. A savings account or CD (Certificate of deposit) is subject to inflation risk as the interest rate stays the same even though inflation may be rising.

 Series I & TIPS government bonds protect your money from inflation risk.

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 Caveat: This article is for information purposes only and may not be appropriate for your individual situation.

A version of this article was previously published.

    3 Comments

  1. Thank you very much!Your article is very useful!

    infant

    May 5, 2010

  2. You can also invest in TIPs via ETFs. There are a few low-cost funds listed on the New York Stock Exchange. These funds are necessarily a better way to invest than buying TIPs dircetly. It is just another option available.

    ctreit

    May 5, 2010

  3. @cool & @ infant, Thanks for reading. I appreciate your comments and visits! @ctreit- Yes, ETF’s are great for occasional purchases, thanks for mentioning. Although, they aren’t great for frequent purchases since you pay commissions on each ETF transaction. Best regards, Barb

    Barb

    May 7, 2010

Trackbacks/Pingbacks

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