Here's a Tip: Buy TIPS

04/14/2008 12:00 am EST

Focus: BONDS

Curtis Hesler

Editor, Professional Timing Service

Curtis Hesler, editor of Professional Timing Service, says inflation-protected securities are a good bet in today’s rocky market, and he suggests a couple of ways to buy them.

In a new paradigm where risk will become a paranoid obsession with investors, a few Treasury Inflation-Protected Securities (TIPS) make sense for income.

TIPS are US government bonds issued by the Treasury Department. They come in terms of five, ten, and 20 years, and you can sell them in the “after” market. The interest rate on an issue is determined at auction, and they are sold in increments of $1,000.

The principal is adjusted for changes in the Consumer Price Index. If the CPI increases, the principal increases. If the CPI falls, the principal will be adjusted lower. “The relationship between TIPS and the CPI affects both the sum you are paid when your TIPS mature and the amount of interest that a TIPS pays you every six months,” [according to] the Treasury Direct Web site.

“TIPS pay interest at a fixed rate. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases. At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. This provision protects you against deflation.”

The subtle trick, of course, is use of the CPI and the shameful government manipulation of that number. It is not actually a measure of inflation in a true sense, but it is the guide the Treasury uses to value TIPS.

Nevertheless, TIPS have proven a decent investment, especially considering that the risk is as low as you can find anywhere. Buying TIPS in a Treasury Direct account will give you the safest way to invest fixed income money. The term is longer than Treasury bills, but you are not locked into a set yield as you are with typical longer-term bonds. As inflation rises, the CPI must rise as well to some extent, and the TIPS will reflect that in higher yield and augmented principal.

There is an another way to buy TIPS, but you will assume some minor added risk. You can buy the iShares TIPS ETF (NYSEArca: TIP). The added risk is that this is an exchange traded fund complete with all the complex workings that allow ETFs to exist, and they are dependent on the fund managers to do their job.

Nevertheless, this is not a bad way to go with a little money. They are about the same price as when I wrote them up last month when they were selling for $109.84, but I continue to advise purchase at $106 or less. The indicated yield is about 5.8% at that price, and they are less risky than most equity investments these days.

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