HERE IS A GUARANTEED WAY FOR YOUR MONEY TO KEEP PACE WITH INFLATION-Part 1

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Category: investing, bonds

 “Inflation is the one form of taxation that can be imposed without legislation.” Milton Friedman

 One economic problem we avoided in recent years is the inflation monster. As Milton Friedman, the famous economist mentioned, inflation is just like a tax and makes EVERYTHING YOU BUY MORE EXPENSIVE! It is really painful when the soda 12 pack you bought last year for $2.50 costs $4.50 this year. That’s the sting of inflation.

MAIN TOPIC; Be Prepared When Inflation Hits 

I received this letter recently and it got me thinking about inflation:

Linda wrote:

Q. – I read in the AARP magazine about Series I Savings Bonds.  Right now they are a little over 3% and they are variable depending on the market.  You have to keep them in for 1 year, and after that if you take the money out you lose the three most recent months’ interest. Any comment?

 Even though we don’t have much inflation now, it’s certain to increase in the future!

Let me disclose that I started buying inflation protected investments for my daughter in 2000. I exchanged some EE bonds she received for gifts for inflation advantaged bonds. At that time, I looked at both SERIES I SAVINGS BONDS and TIPS (Treasury Inflation-Protected Securities). Even in the recent tame inflation environment, these inflation advantaged investments performed well.

 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 government bonds protect your money from inflation risk.

Although we have low inflation in our economy currently, it will likely increase in the future. These inflation advantaged government bonds are sensible investments to look into if you’re interested in preserving the purchasing power of your investments. They are more conservative than an investment in the stock market; unlike stocks, you don’t have the chance for an outsized gain (or loss) with I bonds. On the other side, you are assured that your purchasing power won’t decrease. If your soda expense goes up, so will the investment value of your I bonds!

 To give you the full INFLATION FRIENDLY INVESTMENT PICTURE, I’ll talk about I bonds in this post and TIPS in the next. That way you have a few days to digest the information.

 PRACTICAL APPLICATION: Get all the Facts

 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.

It’s Quite Simple!

 The fixed interest rate is set when you buy the bond.The fixed interest rate stays the same for the life of the bond.

 The adjustable part of the interest rate:

            Changes every six months

             Is based on the Consumer Price Index for Urban Consumers (CPI-U)

The fixed and variable interest rates are combined.

Every six months the composite interest rate changes for the I Bond.

From November, 2009 through April, 2010 the I BOND’S EARNINGS RATE was 3.36%.

            Fixed rate = 0.30%

            Adjustable rate = 3.06%

 How much do they cost?

 You can buy them on-line here  or at a bank. They can be purchased for $50, $75, $100, $200, $500, $1,000, or $5,000. You can even set up an automatic direct purchase for the bonds. You buy them at face value (i.e. you pay $50 for a $50 I bond).

When are earnings added to the I Bond?

The I Bonds increase in value on the first day of each month as they earn interest and increase in value.

The interest is compounded (add link to the magic of compounding) 2 times per year.

When can I cash the bond in and how long does it continue to earn interest?

You can cash the bond in anytime after 12 months, BUT-if you redeem the bonds within 5 years of purchase, YOU LOSE 3 MONTHS OF INTEREST PAYMENTS.

The bonds continue to earn interest for 30 years.

When you cash the bond in you get the original purchase amount of the bond + all of the compounded earnings. Learn about the wonderful benefits of COMPOUNDING.

Since you don’t want to loose interest, it’s a good idea to purchase these investments if you can hang onto them for at least 5 years.

What else do I need to know?

They are subject to federal tax only, NOT state or local. And you don’t have to pay the tax until the bond is cashed in.

 Here’s a great flyer that compares I government bonds with Series EE government bonds.

ACTION STEP:

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

 Jot down the advantages and disadvantages for this investment for you. Visit the treasury website to get some more information about these investments.

 BE SURE TO WATCH FOR MY UPCOMING ARTICLE ABOUT TIPS (Treasury Inflation Protected Securities) for another inflation beating investment.

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