People always say that a dollar doesn’t buy what it used to, and you know what… they are right. That is the power, often destructive, of inflation.
Loosely defined, inflation is the year after year increase in what we buy, so goods (food, consumer goods) and services (computer repair, fancy nail jobs). As inflation increases, what we can buy for a dollar becomes less and less. Inflation isn’t inherently evil if people are prepared for it, and one of those ways to prepare is to purchase Treasury Inflation-Protected Securities.
Most investors consider Treasury Inflation-Protected Securities to be a low risk investment for a couple of reasons. The government of the United States, being the largest economy on the planet, guarantees the securities with the power of the US dollar. The par value of the securities are also increased in the event of inflation, so the principal is protected, and with a fixed interest rate, the negative impact of inflation is nearly eliminated.
How to Buy
The Bureau of Public Debt issues Treasury Inflation-Protected Securities. The office has the responsibility of issuing government debt instruments, in order to raise the necessary funds to run the government and it’s offices.
TIPS are purchased through banks and brokers, and can be purchased as a competitive or non-competitive bid. A non-competitive bid is when the investor buys the security at the asking price, and involved little in the way of negotiation, while a competitive bid is the opposite. In a competitive bid, the investor sets the limits they will pay, much like a market order in stock trading.
There are a few things to keep in mind when trading Treasury Inflation-Protected Securities. The securities can only be purchased with specific terms, namely 5; 10; and 30 years. The minimum purchase amount is one hundred dollars, while the maximum in a non-competitive bid is five million, and for a competitive bid, thirty five percent of the offered auction value.
The Treasury Inflation-Protected Securities are issued in electronic format, so there is no tangible asset to hold, only to track. That does make them easier to reproduce, should the issue arise.
Finally, there are taxes. The interest that you get on the principal investment in the Treasury Inflation-Protected Securities is only subject to federal taxation, and is exempt from local income taxes, and the state cannot put their claim on it either.
Why Buy TIPS
Putting all your eggs in one basket only works at Easter. When it comes to investing, it’s always important to diversify. And for those approaching retirement age, a guaranteed investment that holds up to inflation can provide a sense of security in the later years.