But first, to correct an error from yesterday:
Mike Dominy: ‘Your column today mistakenly stated that military members received matching funds for the Thrift Savings Plan. Only civilian government employees in the Federal Employee Retirement System get matching (up to 5%) contributions. The TSP is still a fantastic idea for military members because the contributions they make are deducted from their pay before taxes and all earnings are tax-free until withdrawal just like a 401K. This is actually the US Government’s version of a 401K for us government employees.’
☞ Germaine Oliver (whom I quoted yesterday) adds: ‘The retirement the military gets at 20 years is what Uncle Sam uses instead of matching. But TPS is still pre-tax dollars, invested in index funds with extremely low management fees. Irresistible.’
And to address the glove compartment issue:
Mike Elwood: ‘Back in the late 70’s when I got my first car (a 1963 Buick for $50!) I put ONLY a pair of gloves in the glove compartment. These would usually be discovered by some nosy person riding in my car. They would always ask ‘Why are these gloves in here?’ and I would smugly respond ‘Don’t you know anything? That’s the GLOVE COMPARTMENT!’ The joke got old and I haven’t had gloves in there for years.’
☞ Yes. And I would have thought you were the very last person to put gloves there – until I heard from Wayne.
Wayne Arczynski: ‘Actually, if you owned a sports car, you would understand that gloves are the only item that belong in the glove compartment. (Ok, maybe the manual and registration card too.) I’m not talking about the hundreds of wannabe sports cars out there. Next time you’re in a true roadster, check out the glove compartment. You may find … gloves.’
☞ So you’re saying a 1996 Saturn is not a true sports car? Bum me out!
And now to begin today’s column:
Michael Choquette (Re: “Tomorrow: The Safest Investment in the World”): ‘I think the safest investment in the world is early payment of my mortgage principal. I’m anxious to see what you consider it to be.’
☞ Well, that one’s awfully good, too. Even better: paying down your high-interest credit-card balances, if you carry them. But I was thinking of TIPS – Treasury Inflation-Protected Securities, first discussed here about 15 months ago. TIPS are, quite simply, the safest security in the world. Why? Because bonds have two big risks – the credit risk (that they could default) and the inflation risk (that they could pay off – but in dollars worth less than you envisioned). Well, of all the debtors least likely to default, the United States probably ranks first. And because the principal amount of these bond rises with inflation (but cannot fall below $1,000 with deflation), the interest you get in effect sits on top of inflation.
The biggest catch: each inflation adjustment is taxed as ordinary income in the year it’s made, even though you don’t receive it until you sell the bonds. So TIPS only make good sense for a tax-deferred account. (For taxable money, consider Series I Savings Bonds.)
I called my full-service broker at a very large firm to see about buying them for my Keogh Plan. He had never heard of them. It took a couple of weeks of phone tag and research on his part to get up to speed. (My deep discount broker was knowledgeable from the first call.) I tell you this not to knock full-service brokers, but to make this point: that if there’s little or no juice in a particular security for the brokerage firm, they have little or no incentive to train their reps in its virtues or steer you toward it.
For the ins and outs of TIPS, click here.
The simplest way to buy them is when new TIPS are issued, if they ever are, through Treasury Direct.
If you don’t want to wait for the next new issue, you can call your broker and buy an existing issue in the open market. The $1,000 bond will be multiplied by a ‘factor’ expressing its inflation since issuance. For example, on the 10-year 4.25% bonds issued January 15, 2000, the inflation factor was recently 1.05706, so buying 100 bonds would have been buying not $100,000 of principal value, but $105,706. And it would have been on that amount, $105,706, at least until the next adjustment, that you would have been earning your 4.25% annual interest.
The problem is that smart shoppers have already been attracted to the virtues of The Safest Little Security in the World, and so have bid up their price. When I checked this bond last week, you wound not have been able to buy it for 100 cents on the dollar ($105,706 in this example) . . . but rather for about 107 cents on the dollar. That extra 7% premium was the amount by which the market had bid up the price of the bonds above their intrinsic value. So for 100 bonds, you would have paid a little north of $113,000.
In the future, that 7% premium could expand even more (or not) until eventually, inevitably, it shrinks back down to zero on January 15, 2010, when the bonds are redeemed at whatever is then their inflation-adjusted intrinsic value.
So buying The Safest Little Security in the World in the open market this way now brings with it Two Risks, which make it a little less appealing. First, that – should you buy them today and decide to sell them next month – the 7% premium might have shrunk. Second, that the inflation already built into each bond could be deflated back down somewhat (but no lower than the $1,000 face value).
These are not terribly big risks.
- The 7% will gradually shrink to 0% as we get closer to redemption (although it could widen first). But that just means people are looking at the 4.25% return atop inflation and deciding that they are willing to accept less. (Paying 107 for a 4.25% bond lowers its current yield to 3.97% because getting $4.25 a year on $107 works out to 3.972% . . . and lowers its yield to maturity – which is its true yield that factors into the calculation the loss of that extra 7% premium you paid – to 3.4%.)
- So the market for this particular bond is saying, “I would have loved to get 4.25% atop inflation when these things were issued but, spilt-milk and all that, I’m willing to settle for 3.4% atop inflation instead.”
- As for deflation, that’s even less of a risk I think, in this sense. Yes, we might have deflation – we really might. But in this example, with the inflation-accreted value of the bonds right now only up to about $1,057 for each $1,000 bond, your maximum exposure would be $57. But if we had terrible deflation (which I certainly do not expect), you’d be sitting prettier than a prom queen, because burgers would cost a dime, lakefront homes would go begging for $40,000 – and you’d still be guaranteed $1,000 for each of your bonds at redemption.
- The deflation risk would be greater for someone buying these 4.25% TIPS of 2010 in 2008, say, if the inflated intrinsic value had risen to $1900 a bond (because we had had several years of terrible inflation – which I also do not expect), and then the world economy plunged into a deflationary depression. There you would have been, paying $1,900 a bond in 2008, only to see them redeemed at perhaps no more than $1000 two years later.
- (I tell you all this not because I expect terrible inflation or deflation, but because by taking extreme examples, it may help to see how these bonds “work.”)
The bottom line of all this? You might want to consider TIPS for a portion of your tax-sheltered money. Not if you’re young. But say you are 70 and not sure you want to bet all your retirement money on a stock market that is still, by some measures, very, very expensive.
As many of you know, Charles and I are TiVociferous. When we’re someplace without TiVo, I get so angry that I can’t pause the news, or “backspace” to hear something I missed, or see one of my favorite shows just because I forgot it was on – or got back from dinner too late to see it. I got so enthusiastic about TiVo, I even bought a few shares of the stock. (Talk about a brainless speculation!). But with that conflict of interest disclosed: If you’ve been thinking of getting one, click here for a $100-off deal they just announced – $249 for the machine, and free shipping. (But don’t forget you must then pay either $10 a month or a one-time $249 fee for the service.) Note: If you are in credit card debt, forget it. And cancel your cable and get rabbit ears. First things first!
Quote of the Day
Triumphant wife to down-and-out husband: I've consolidated all our bills into one missed payment.~Frank Cotham cartoon in the October 11, 1999, New Yorker
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