Year: 2000

Kathleen: “My Dad got one of those stocking stuffers, but he hasn’t read it. He’s 83 and doesn’t read as quickly as he once did. He reserves his reading hours for the important stuff — the morning newspaper and Sherlock Holmes. So he hasn’t read your discourse on why-not-to-buy-an-annuity, and I never dreamed it would be important to him.

“However, the folks at the brokerage through whom my parents have invested for the last 30 years suddenly tried to sell my folks an annuity last year. My parents asked my opinion about this (a request that is out of character for them, but one that I take very seriously), and I’m trying to advise them well. But I’ve run out of ammunition in what’s turning out to be a battle with the brokers, and I’m hoping you can tell me where to find another stockpile. No pun intended. Here’s the deal.

“My Dad has a generous retirement plan, complete with very generous survivor’s benefits for my Mom, if needed. The two of them live comfortably on that income, so they never touch their investments, many of which are in stocks, bonds, and a family of mutual funds (owned by this brokerage house, of course).

“Last fall, the brokers advised my folks to buy an annuity (knowing little about my folks retirement plan or investments through other brokers). The major selling points were: First, guaranteed income for the surviving spouse. Second, tax free growth.

“We informed the brokers that income guarantees were already in place. We said my folks weren’t interested in paying fees to get in and out of something they didn’t need in the first place (surrender fees were something like 15% prorated over the first 10 years). The brokers urged us to give it some thought anyway and get back to them. We didn’t.

“The guaranteed income didn’t carry much weight, but the tax free growth did. My Dad is one of those folks who firmly believe the government gets way too much of his money in the first place, and just the sight of the I.R.S. acronym is enough to trigger a diatribe. So the brokers scored a direct hit on that one, but it wasn’t enough to sell the annuity.

“They called my folks a few times over the last three months to talk about ‘this or that,’ always asking whether my folks had come to a decision about the annuity. This needling succeeded in making my folks start to doubt their own common sense — after all, ‘if these brokers are so convinced we need this, maybe we really do!’

“Last week, the brokers presented a different package, a ‘Freedom’ annuity with ‘no’ initial or surrender fees. They are advising my folks to invest a tripled amount of money in this annuity, as opposed to the surrender-fee-laden annuity they originally offered. I can only guess that the amount tripled in order to make up an equivalent sales commission for the brokerage house, assuming a no-fee annuity pays a smaller commission than a heavily-fee’d one does.

“In a rather heated discussion at the brokerage house on Friday, I countered the ‘no fee’ arguments by showing my folks the mutual fund management fee numbers in the prospectus. The brokers parried with the statement that these fees were negligible, then launched the most deadly missle. They told my folks that putting their money into an annuity guarantees it against liability lawsuits, something that no other investment instrument can do. ‘If somebody decides to sue you tomorrow for any reason, they could take all your money except what’s in this annuity — the courts can’t touch this money.’

“Now this is a powerful argument to my folks. The older they get, the more menacing the world seems to be. And it makes me livid that these brokers are exploiting this fact by offering them an annuity, of all things, to protect them from the evils out there.

“But I don’t have much time for anger because I’m sure the brokers will be following up a.s.a.p. on this latest attempt. So, I’d be grateful if you’d answer these two questions: First, is it true that an annuity protects assets against liability claims? Second, doesn’t personal liability insurance do the same thing? I.e., if you’re worth $100,000 and you buy $100,000 of personal liability insurance, then your assets are protected, right?”

It sounds to me as if the main evil out there that your folks need to defend themselves against are these brokers.

One thing you might do is use Personal Fund’s Mutual Funds Cost Calculator to check out the funds your folks have been sold. If the fees are high and the performance mediocre, as I suspect may be the case, your folks might begin to see that the brokers’ first interests are their own commissions.

I’m not saying an annuity is never a good idea for an 83-year-old, especially if he/she seceretly “just knows” he/she will live much longer than the actuaries think. (The actuaries think an 83-year-old in good health will live a LONG time. Click here to play Northwestern Mutual’s “Longevity Game” and see how long you and your parents will live.) But the reason for buying an annuity at age 83 is peace of mind, not tax-deferral, and you should shop around like crazy for the best buy — NOT buy it from someone trying to sell it you. Be a BUYER, not a SELLEE.

To begin to get an idea of what sort of lifetime income your folks might expect from a fixed annuity, you might try getting a quote on-line from Berkshire Hathaway Life.

Now as to your specific questions:

<< Is it true that an annuity protects assets against liability claims? >>

Let’s assume that it is. So what? Because, in the first place, your parents are highly unlikely to be sued, and, second . . .

<< 2. Doesn’t personal liability insurance do the same thing, i.e., if you’re worth $100,000 and you buy $100,000 worth of personal liability insurance, then your assets are protected, right? >>

No, but you’re on the right track. Your parents should pay the $150-$250 a year it will cost to buy a $1 million “umbrella” liability policy. In the highly unlikely event they are sued, this extra $1 million would ordinarily be more than enough. If they wanted, they could buy even more.

But note: The coverage you need is not based on the size of your assets, but rather the cost of potential lawsuits. Having $100,000 in liability coverage will not protect even a $38 net worth if you lose $200,000 in a lawsuit. Right? The coverage would still leave you $100,000 short, which would wipe out your $38 net worth and still leave you $99,962 in the hole.

And note: Umbrella liability policies sit on top of your existing auto and homeowners liability coverage. The umbrella carriers require that you carry high levels of liability coverage before they will write that extra $1 million . . . so your folks may need to increase their coverage in order to qualify to buy an umbrella policy. (Note also that umbrella policies cover you against most kinds of personal liability, but not professional liability or liability connected with your business. If you poison all your dinner guests by Cooking Like a Guy™, and they sue, you are covered. But if you open a Cooking Like a Guy™ diner and poison them, or amputate the wrong patient’s leg, you’re not covered.)

To obtain umbrella coverage, start by calling your existing auto or homeowners insurer and asking what they have to offer. As I say, for most people, a $1 million umbrella should not cost much more than $250 a year, if that.

Coming Soon: What Berkshire Hathaway — Warren Buffett’s company — wants to sell you.

Linda Tam: “I just noticed that when I am at your homepage, the little tab at the bottom of my Windows screen, representing Netscape, reads ‘Andrew Tobias – Dem…’ What luck that you did not call your site, ‘Repositioning Finance!'”

Speaking of which, I just got an URGENT envelope — Registration Materials Enclosed . . . OPEN IMMEDIATELY — that turned out to be from Jim Nicholson, chairman of the Republican Party, inviting me to join the President’s Club and get my credentials for the Republican Convention. Because of the extraordinary demand for this, Jim writes, “I can only hold your reservation for the next 7 days. If I don’t hear from you by then, I will be forced to extend your invitation to another party leader.”

But then he continued, “that is the last thing I want to do. Because I believe YOU are the caliber of person we need. . . . to join the team of advisers and confidants I will turn to for strategy and advice on how to return Republican leadership to the White House this November.”

This got me to thinking. I decided that, while I would not send the $1,000 (down from last month’s $5,000 invitation to join the Republican Presidential Roundtable), I really ought to chip in with some advice.

After all, Jim had written me a four-page letter . . . and he and the treasurer of the RNC had hand-signed (well, almost hand-signed) a framable certificate “In recognition of [my] proven commitment and dedication to the Republican Party.”

As the treasurer of the DNC, I have special respect for this sort of thing and, as I say, felt I really should offer some advice. So here it is: Don’t take any chances. Go with a proven strategy. Bush/Quayle. You may even save on some left-over campaign materials.

Decency requires me to acknowledge that there is no significance to this little story. Direct mail, sadly, is direct mail. Sure the RNC looks silly sending me this. But it would not amaze me if we ourselves had at some point congratulated Jesse Helms on being a great Democrat. (Well, maybe not that.)

But I’m still going to frame my certificate.

In a bull market, people wait eagerly for dips, hoping to buy, feeling foolish they had not gotten in earlier. This eagerness to buy on dips limits the downside — and people know it does, which feeds the bullishness, which can last a long time. At the top, there may even be books with ridiculous titles like, “Dow 36,000.”

In a bear market, people wait eagerly for rallies, hoping to sell, feeling foolish they missed the chance to sell much higher. This eagerness to sell limits the rallies — and people know it does, which feeds the gloom. This, too, can go on for a long time.

Ultimately, of course, a bull market will be brought down by . . . something (usually, rising interest rates followed by a recession), and stock prices that may have climbed above all reasonable levels of valuation will decline back toward those levels. Indeed, they will often keep falling well past reasonable valuations.

And then at some point — very quickly or only after a long time (one only knows with hindsight) — the bear market will end, as selling pressure is exhausted and psychology turns (possibly because the Fed has signaled that high interest rates can safely begin a downward trend).

Where are we in this cycle? Your guess is as good as mine. The market certainly doesn’t feel very bullish here, yet prices of most stocks are hardly cheap, let alone irrationally so. So we may be in just the early stages of a bear market.

Or we may already have weathered the worst of it, in large part because some highly positive trends that underpinned the bull market may continue:

• Tremendously exciting advances in technology that greatly enhance human productivity. (But by making price comparisons so easy, and price competition so fierce, might they also decimate profits?)

• Generally lower defense spending that frees up capital and labor for more productive endeavors. (But are arms build-ups gone forever? Are major conflicts a thing of the past?)

• Generally freer trade that works to make the world economy more prosperous and efficient (see Ec 1: the rules of comparative advantage).

• Globalized communication that works in favor of democracy (it’s hard to keep people in the dark, or keep them from organizing, once there’s a modem in the village) . . . and that, thus, works in favor of peace (democratic governments do not start wars). But what do we do if one of these viruses ever DOES destroy all the world’s data? You remember the Plague that devastated Europe? Now we have a new kind of plague to worry about. CyberPlague.

So who knows where we are? You decide: are you, personally, eager for dips so you can buy — or for rallies so you can sell?

And how will you feel five minutes from now, when stocks have switched directions?

The column that ran Friday was an error. What I had meant to run, and had posted the night before, is the column below.

The first I realized anything was wrong was Friday morning, when I started getting e-mails about princes of Egypt. Huh? So I went and looked at the site myself and saw that — oops! — the machinery that underpins the postings had taken it into its own head to rerun the column from May 18, 1999.

Though quite a few of you wrote in to tell me why things are, or are not, not that much better now than in days of old (David Smith: “I can make a flawless one-word argument: ANESTHESIA”), practically no one seemed to notice or care that the column had run before. So I may just keep running it.

The problem arose, I learned, because I had apparently run out of rented disk space at my web hosting service. A couple of e-mails later (and another few dollars a month), and I can now write four million more words before you have to read this again.

Anyway, here was what you were supposed to be reading Friday:

THOSE CANDLE STOCKS

Chris Kueffner: “Would you please also refer me to your column with the several specific stock/company selections you mentioned some time back (maybe as much as two months ago). There were something like 4 or 6 of them and I believe one of them was BTH. You presented them more or less as choices by people who know how to choose and do well with their money.”

It was March 14. But please note that, having risen 38% in two months, while much of the rest of the market was not doing as well, this basket of stock picks is less enticing than it was. Contrary to what momentum investors believe, when a stock has quickly become more expensive, it is not more of a bargain. (Please note also that, as you say, these were not stock picks based on my great judgment or research. My judgment is generally suspect and my research, generally spotty. Rather, as I explained in March, they came from a friend whose judgment and research are much better.)

MANAGING YOUR MONEY

Robert Doucette: “Whenever you (or another faithful reader) talks about MYM, I can almost hear a heavenly choir and see the celestial lights. Could you tell us what you do with MYM that is so compelling? I’ve used Quicken for years, but only to balance my checkbook and allow me to look up past spending. What am I missing?”

I’d tell you, but because MYM-DOS12 is completely unavailable and orphaned, and so impractical for someone starting out now even if he could find a copy, this would only serve to taunt you and make you feel rotten. Suffice it to say that, among its other features, MYM told you jokes, regularly doubled your net worth with no risk, delivered breakfast in bed when you were feeling flu-ish, and even filled in at water volleyball when you were a man short.

DUMB GIFTS

Mike: “Is there an inexpensive means of purchasing single shares of a stock to be given as presents (e.g., a relative collects Coke memorabilia)?”

Buying a single share is more of a nuisance than anything else. It has no real investment value. (Even if the share zooms, it still won’t amount to Real Money, and they’ll hate you — or themselves — for not having bought more.) And you force the company to waste money sending out annual reports, etc.

Why not buy 1000 shares! Old, canceled ones, that is. Nice to frame, and less of a hassle for everyone. See, for example, Scripophily.com. They’re having a sale on EuroDisney Certificates even as we speak.

JUST THE KINDA GUY WE’RE LOOKING FOR*

John Lemon: “I enjoyed reading the contribution from the CISCO executive a few days ago. You published that piece one day after a young friend of mine, an executive with an S&P 500 company, purchased a ticket for a business trip from a Midwestern U.S. city to London. This company’s policy is to pay for Business Class on such flights unless Business is booked, in which case they will pay for First. My resourceful friend conducted an extensive Internet search for a flight that was already sold out in Business Class and purchased a First Class ticket for that flight. Price: $9,300.”

*And when we find him, it won’t be pretty.

I got almost entirely negative feedback from yesterday’s two-word column.

• Most of you pointed out — rightly — that the writer whose work I directed you to badly blew it in saying PCs were rare in 1986, and so on.

• A few of you went much further, to say what a liar you thought one of the presidential candidates is. Which just makes the point of how scarily misreported all this has been.

• But the best criticism came from one of you who said — again, rightly — that I had picked the wrong column to point you to. Broader and more compelling is Robert Parry’s now pretty famous article in the Washington Monthly. Please click here to read it — especially those of you who wrote to say I was nuts — and let me know what you think.

I apologize to those of you who think this is not a topic for a money-oriented web site, but to my mind we are being asked to evaluate two candidates for, among other things, CEO of our economy. So I think it’s worth shareholder discussion.

On an entirely separate topic, I was delighted to see Quickbrowse — which has gotten a lot better since I first brought it to your attention — featured in Walt Mossberg’s Wall Street Journal column this morning. (I read it a few hours ao when it went on-line.) He singled out Quickbrowse as his favorite of the new “metabrowsers.”

Quickbrowse.com currently has three main components. (If you fail to reach it this morning, because half a million Journal readers are trying at the same time, give us a second chance later. They tell me we should be able to handle the load, but . . . well, famous last words.)

• QB-Masterpage, lets you stitch together a whole lot of disparate web pages into one huge long one. There’s more to it than that, which is why its true usefulness, though nicely reviewed around the world by now — and so nicely in the Journal this morning — still takes some brow-furrowing to fully appreciate. We’re working to make it even simpler.

• QB-Search, is about as simple as it gets. If you ever use search engines, why wouldn’t you always do it through us? Just bookmark QB-Search, and then — instead of going to Yahoo and then Alta Vista and then Google, etc. — go to all of them (or any combination of them) at once! See the first page of hits from each, or the first five pages — whatever you want. I could elaborate, but just go see for yourself. (I’d leave “result pages per engine” set at 1 or 2 to start.)

• QB-Stocks, is brand new. It needs to be fleshed out over the next week or two, but it’s also completely simple. Enter some stock symbols, enter the message boards you like, and click. QB-Stocks pulls together all the postings. You can, in fact, bookmark the “results” page and, from then on, check the messages on all your stocks from all the message boards just by clicking that one bookmark on your browser.

As I say, Quickbrowse is still a work in progress. But it’s coming together pretty fast now. Free, of course. We hope you find it useful.

Click here.

Tuesday Is Election Day.

Not this Tuesday, but Tuesday in general — and today is Tuesday.

Are you registered to vote?

A lot of people do mean to vote, they just never get around to registering. Because, well, how do you even do it?

Easy!

Just choose your state (from the lower of the two pull-down menus), and click GO.

I can understand why people aren’t buying Treasury Inflation-Protected Securities (TIPS). As described Friday, they’re new; there aren’t many choices on holding periods; buying and selling them require brokerage fees unless you can wait for the infrequent Treasury auctions and hold to redemption; and the inflation adjustment is taxed as income each year even though you don’t actually get it until you sell. Also, you can only buy them in $1,000 increments.

So what if we add about 50 more years of familiarity; let you choose any holding period you want between 5 and 30 years (and you don’t have to decide now); eliminate any need for brokerage or any other fees; not tax either the interest or inflation adjustment until you redeem the bonds — and let you buy them in $50 increments? Will that make you happy?

Welcome to the new world of U.S. Savings Bonds. In 1998, one year after introducing TIPS, the federal government introduced a new form of Savings Bond called the Series I (for inflation, not the Roman numeral) Bond. If you buy one today, you are guaranteed an annual return of 7.49% for the first six months, with the rate adjusted every six months to the sum of 3.6% plus the rate of inflation. And you can buy one online with a VISA or MasterCard card within the next 10 minutes, even allowing 5 minutes to finish this column.

(There’s no surcharge for using a credit card, so, if you have that kind of card, you get the frequent flier miles — equivalent to an extra 2% tax-free return!)

U.S. Savings Bonds started as war bonds paying miserable returns. Patriotism made up the difference — that, and the fact that small savers had no alternatives. There were no money market funds, and the interest on savings accounts was fixed by law at a ceiling that ranged between 1.5% and 3.5% in the Thirties, Forties and Fifties. (Christmas Clubs paid 0%.) Today, we’re not at war and alternatives abound, so the Treasury has had to be more competitive. And it has been. The 7.49% yield on Series I Bonds should be of interest to just about any small saver. A few key facts:

• Series I Bonds are dated the 1st of the month of purchase, and earn interest from that date (so buying late in the month makes sense — you get three or four weeks’ free ride).

• They can’t be redeemed until the bonds are six months old.

• If they are redeemed before they are 5 years old, the last 3 months of interest is lost. But at today’s rates, holding them for just 2 years and then redeeming them will probably outperform most 2-year CDs even after losing the last 3 months’ interest (especially if you pay state income taxes, since Savings Bonds are exempt from these).

• They stop earning interest after 30 years.

• The interest is accrued monthly (compounded semi-annually), and you can, if you wish, elect to pay taxes on the growth without waiting for redemption. That could make sense for bonds in the name of a child in a low tax bracket. Little or no tax would be due each year; and, by satisfying the tax man on a pay-as-you-go basis, no tax would be due at redemption.

• These are such a terrific deal that the government limits calendar year purchases to $30,000 for each Social Security number. If you’ve got much more to invest, you might want to take another look at TIPS, which are currently promising over 4% plus inflation (but with that rotten tax to pay each year on the inflation adjustment, even though you don’t receive it).

A small additional advantage for seniors:

Seniors are required to pay taxes on up to 85% of their Social Security benefits if their “provisional income” exceeds certain amounts. Many have learned to their annoyance that tax-exempt municipal bond interest is included in calculating provisional income, and can thus bump up the taxable portion of the Social Security benefit. Savings Bond interest, however, is NOT included in provisional income until you actually redeem the bonds (unless you elected the pay-as-you-go approach mentioned above).

A possible advantage for tuition payers:

Normally, the tax on Savings Bond interest is deferred as it accrues, taxable in full when you redeem the bonds. But if someone at least 24 years of age buys a Savings Bond and then, years later, spends the proceeds upon redemption for college tuition, fees, and books (personally or for a dependent), the interest can be entirely exempt from taxation. Say you’ve got a 13-year-old and are frightened by the short-term prospects for the stock market. It is worth considering that a tax-free 7% might be pretty hard to beat (of course, if inflation drops, the return on these bonds will drop, too; but the converse is also true). Unfortunately, the exemption is phased out for higher income taxpayers, and there are several confusing restrictions, so you’d better check the rules carefully if you’re really counting on this one. Note that you CANNOT hold the bonds in the name of the child and get this benefit (the owner, remember, must be at least 24 on the date of purchase). By the way, if you redeem savings bonds and put the proceeds into a 529 qualified state tuition plan, that is considered a qualified higher education cost itself and will exempt the interest on the bonds from taxation if the other requirements are satisfied.

A final word or two:

TIPS and Series I Bonds are attractive for small savers. They’re totally safe and protect against inflation. TIPS would be good for a retirement account. Otherwise, Series I Bonds probably make more sense. Large, high-tax-bracket investors might prefer municipal bonds — after all, munis are tax-free, not just tax-deferred. Then again, they don’t currently pay as much as TIPS or Series I Bonds, and if inflation rises, muni-owners will fare worse than TIPS- or Series I Bond-owners. (If inflation falls, muni-owners will fare better.)

We started this discussion looking for a safe place for 5-year money. For many savers, Series I Bonds fill the bill.

And you’ve still got 5 minutes left to buy some. (You can buy as little as $50 or up to $500 online at one time.) Check out savingsbonds.gov. You can stop at any time before hitting the PAY button. Just find out how easy it is. And see if you can figure out who those people are on the different bonds. That’s Martin Luther King, Jr., on the $100, but who are the others?

I mentioned yesterday that, based on the experience of the years from 1926 to 1999, the safest possible place for money you planned to hold 5 years was a blend of 55% in cash (well, Treasury bills or money-market funds) and the rest split equally between U.S. and international stock portfolios. The worst you would have done in any 5-year period was a “real” rate of return (after inflation but before taxes) of minus 2.35% per year.

Losing 2.35% a year for five years turns $10,000 into $8,879. Not too awful for a worst-case scenario.

But what if I offered you a deal with a GUARANTEED POSITIVE return of 4.25% per year above inflation, exempt from state and local income taxes, and with no risk of default? Would you turn it down? Well, millions of people just did, in the January 2000 auction of Treasury Inflation-Protected Securities (TIPS).

Consider this: over long periods of history, stocks offer real returns of around 7% (after inflation but before brokerage or mutual fund fees, expenses and commissions, and before tax). To get that, you have to endure a roller coaster that periodically cuts your investment in half and requires great staying power. Most people, through commissions, annual mutual fund expenses, bad market timing, big allocations to cash or bonds for safety, and foolish short-selling (I was so dumb!), do considerably worse than 7% after inflation.

So why not settle for a completely safe and simple 4.25% above inflation? Why aren’t people falling in love with TIPS? I have some theories:

(1) They don’t know about them or understand them.

Okay, let me solve this one first. TIPS are sold in auctions by the Treasury in multiples of $1,000 and then trade regularly until maturity. The bidding is for the cash yield (as I said, the last auction produced a 4.25% yield). This yield is paid on the face value of the bonds semi-annually (2.125% per six months for the January 2000 10-year TIPS), just like other Treasury notes and bonds. The difference is that the face value is adjusted automatically for changes in the Consumer Price Index for Urban Consumers (CPI-U). So both the face value and the interest payments are going to go up with inflation (and down with deflation if we should have it, though never below the original face). Your real return to maturity is guaranteed.

(2) They think the government might change the way the CPI is calculated.

I understand this fear, since many believe that the CPI-U overstates inflation by 0.5% to 1.5% per year, and there is now an alternate CPI-U being computed that supposedly is more accurate. People who are suspicious of everything the government does are convinced they will switch to the alternate method and reduce the returns of these bonds considerably. But even my libertarian friend, the estimable Less Antman, who says, “I wouldn’t trust a government report that said the Sun was going to rise in the East tomorrow,” says that can’t happen, because THERE IS SPECIFIC LANGUAGE IN THE LAW FORBIDDING IT. The rules for TIPS say specifically that any change in the computation of the CPI-U that reduces reported inflation from the old method requires the yield on these be increased to compensate.

(3) The periodic increases in face value are taxed immediately, even though the face value isn’t payable until the bond matures.

It’s true, it’s a bummer, and it was probably a mistake for the Treasury to design it this way. Unfortunately, if you buy a 30-year TIPS, after 1 year you’ll be taxed on a cash flow you’re not going to collect for another 29 years.

There are two points to be made here. First, if you hold TIPS in retirement accounts, this is not relevant. The appreciation won’t be taxed until withdrawn anyway. Second, the premise of this discussion was that we were looking for a safe 5-year return — not 30. The effect of being taxed a few years early is not that significant. (It could even save you money if you’re headed for a higher tax bracket, or if receiving that extra taxable income all at once, in the fifth year, would have bumped you into a higher bracket.)

Also, if you’re using TIPS in a custodial account for your teenager, the taxation will be pretty small.

Nevertheless, the government blew it here. If you own a $1,000 TIPS with a 4% yield and we have 3% inflation, you’ll receive a bit more than $40 in cash but be taxed on a bit more than $70. For the average person in the 28% bracket, that works out to around $20 in tax payments, or 50% of the current yield. If inflation gets really bad, you could actually owe more taxes than the entire yield, with years or decades to wait for recovery (and a probable drop in the market price if you want to sell early).

And a footnote to the retirement-account solution to the tax problem is this minor but annoying little twist. Namely, that TIPS, being Treasury securities, are meant to be free of state and local income tax. Yet if you own them inside a retirement plan, they will be taxed, when you withdraw them, like any other retirement dollars you withdraw from the account — as ordinary taxable income.

Finally, since I can hear a bunch of you muttering this under your breath, let me spare your having to write angrily to tell me that the government has no right to tax inflation gains in the first place, because they’re not real gains at all! Hey — makes sense to me. I would be perfectly happy to have TIPS designed to adjust for inflation tax-free. That would make them even more desirable, driving down the rate of interest Uncle Sam would have to pay to attract buyers. It might thus not wind up costing Uncle Sam a penny, yet boost their popularity and simplify things. Thanks for writing in to tell me that.

(4) There aren’t any 5-year TIPS.

Okay, you got me there. They tried, though. The Treasury offered 5-, 10-, and 30-year TIPS in 1997, and the sales of the 5-year notes were so miserable they discontinued them (but the 1997 issues are trading in the market and you can buy TIPS maturing in 2002 through your broker). They only sell the 10-year TIPS in January and July and the 30-year TIPS (too long for anything but tax-deferred accounts) in October. Having started in 1997, that means the earliest 10-year TIPS issued in January 1997 are coming due in January 2007, a little under 7 years from now. Obviously, within 2 years we’ll have a steady supply of TIPS that can be bought on the open market with maturities in 5 years (though they probably won’t still be yielding over 4% once people get wise to these). And except for the commission you’ll pay on sale and the tiny discrepancy that might exist between the face and market value of these when you sell (not likely to exceed 1%, and more likely to be a gain than a loss, anyway), a TIPS maturing in 2007 should be reasonable for a 2005 goal.

You’ll have to use a broker to buy a TIPS that is already trading, but can buy new 10- and 30-year TIPS at the auctions directly (even in an IRA) without commissions — or on-line. http://www.publicdebt.treas.gov

So far, there’s one mutual fund specializing in them, the American Century Inflation-Adjusted Treasury Fund, which was founded immediately after these were created, but it is a mark of their unpopularity that the fund still isn’t large enough to have been assigned a ticker symbol! It has a 0.51% expense ratio (not unreasonable for such a tiny fund) that is scheduled to drop when people start piling in.

Also, I believe Vanguard is launching a bond fund to invest in inflation-indexed securities in a few weeks. It looks like TIPS aren’t going to remain a secret for much longer

But before you act on any of this, give me one more day, because there is one other investment that may be even better than TIPS, especially for retirees or those saving for an older child’s upcoming college education.

Monday: 5-year TIPS without taxation

Oh, and thanks, guys. You bought enough copies to get my book up from 2,797 to 468 as of one this morning. That’s what I call teamwork!

Hey, wait. I just noticed that my book has slipped to, like, #2,797 on Amazon. This is embarrassing. Sure, one of the customer reviews gives it only one-star, but he was reviewing the Spanish translation. Please, everybody: buy my book today as a graduation gift for somebody, or for Father’s Day or something. Got to get my book back into triple digits. (Avoid the Spanish edition.) And now back to our regularly scheduled programming.

It’s important to know that the stock market is likely to outdo “safer” investments over 20 or 30 years. But not all goals are that far off. And even for distant goals, most people will not be able to handle a grinding stock market decline without feeling an overwhelming urge to abandon their plan. Someone with a 30-year “rational” horizon may have a 5-year “emotional” horizon. (Day traders appear to have a 5-minute horizon, but day trading has nothing to do with investing.) This last is particularly unfortunate, as investment types and styles often seem to cycle in and out of favor over periods of 3 to 5 years, so that investments that underperform over a 5-year period might overperform over the next 5.

If you are saving for a specific goal that is approximately 5 years away (a house down payment, perhaps), you probably want to minimize the risk of a terrible loss without giving up too much potential gain. We all know that high returns without risk are fantasies. But by diversifying over different asset classes, we might not have to give up too much.

Consider — in real, inflation-adjusted terms — the worst 5-year results of the 20th Century for stocks, bonds, and cash investments. With appropriate thanks to Charles Ellis for providing this information in his excellent Winning The Loser’s Game, the worst compounded annual real rates of return over 5 years since 1901 have been:

Stocks: -11.62% (that is, losing 11.62% a year)
Bonds: -10.48%
Cash: – 7.78%

The worst 5-year stock return would have turned $10,000 into $5,392 of purchasing power. The worst bond return turned $10,000 into a not much better $5,749. The worst return for cash cut $10,000 down to $6,670 (the cash was still there, and even grew with interest, but inflation cut its value).

Interestingly, these worst 5-year periods were not clustered around the 1929 crash, as you might have guessed, but 1915-1920. World War I ignited severe inflation. A basket of goods that cost $100 in 1915 cost $197 in 1920. That killed the stock and bond markets, as sharp inflation always does. But it also slashed the value of Treasury bills (which are what financial types like me mean when we refer to cash), because rates did not float back then as they do today. Today, if inflation ever came roaring back, the yield on Treasury bills would roar back, too. (Then again, these “worst” numbers are before tax. So after inflation and tax, you’d still be losing money at a significant clip, after tax, in Treasury bills, if inflation roared back, even if not quite as fast as in 1916.)

So do you still think stocks are too risky?

Well, OK. But the figure for stocks can be improved considerably by not limiting the investment to U.S. securities. When the U.S. market crashed between 1929 and 1932, non-US investments suffered a much smaller drop and a faster recovery. When Japan crashed after 1989, the rest of the world did quite well. Any investor in any country will be safer by splitting his investments between domestic and foreign securities.

I asked my pal Less Antman — known to regular readers of this column as “the estimable Less Antman” — to determine the performance of a stock portfolio split evenly between large U.S. stocks and large foreign stocks. According to his calculations, using data going back to 1926 (so that the crash of 1929 is included), the worst 5-year real return was -6.56%. Not great, to be sure, but a lot better than the -11.62% compounded annual loss when invested in the U.S. market alone. In this example, $10,000 would have shrunk to $7,123.

Diversifying your stock portfolio globally increases safety.

But I wouldn’t be too thrilled to lose $2,877 of my original $10,000 stake either.

With hindsight, Less reports, a blend of 55% cash, 45% global stocks (US and foreign), provided the “best” worst 5-year return: negative 2.53%, which only reduces $10,000 to $8,797. In other words, from 1926 to the present, the worst you would ever have done with that blend in any 5-year period was to lose about $1,200 in real purchasing power.

That’s a much better “worst” than just owning U.S. stocks and nothing else. A reasonable way to approximate such a blend would be to put half of the funds needed in 5 years into a money market or short-term bond fund, and split the other half between the Vanguard Total Stock Market (U.S.) Index Fund and the Vanguard Total International Index Fund. Or perhaps do it a third, a third, and a third.

But if it’s safety you seek, forget all this. There’s a much simpler way.

Tomorrow: An investment that guarantees you’ll beat inflation (before taxes, anyway)

And still my book sits at #2,797. How about your dry cleaner? When was the last time you ever brought him something besides dirty shirts? Your dentist? Dentists are notoriously bad investors.