Did some of you buy TIPS – Treasury Inflation-Protected Securities – at last week’s auction? These were first covered here May 12th and 15th last year, and I’ve mentioned them a few times since because they are, along with I-Bonds, about the safest investments in the world: guaranteed by the US Treasury, protected from inflation and, at least to a degree, from deflation.
At last week’s auction, the bonds maturing in 2032 were issued with a 3.375% coupon and each bond was sold not for $1,000, like most bonds, but for $983.14. So the $33.75 in interest each bond will pay works out to a rate of slightly more . . . 3.433%. And because each $983.14 bond will be redeemed for at least $1,000 in 30 years, that bumps the ‘yield to maturity’ even a teensy tiny fraction of a hair higher. But the real appeal of these is that their $1,000 face value – and the amount on which that 3.375% is calculated each year – will rise with inflation (or fall with deflation, but not below $1,000).
Let’s assume we average 3% inflation for the next 30 years. That $1,000 bond will then be redeemed for $2,430 instead of $1,000 . . . and the semi-annual interest payments you get will be based on each year’s higher principal. So in that final year, instead of getting $33.75 on each $1,000 bond, you’d be getting about $82 on each $2,430 bond.
All this is rotten in a taxable account, because the ‘accreted principal’ – namely, the inflation adjustment – is taxed as income even though you didn’t receive it in cash. But, in these nervous times, it doesn’t seem too bad at all inside the shelter of a retirement fund.
(For non-sheltered money, you might want to consider I-Bonds. Or buying shares in one of the mutual funds that specialize in inflation adjusted bonds – I think Vanguard has one – and that pay out the inflation adjustment in cash each year. You’d still have to pay tax, but at least it’s on something you actually got.)
If you’re 25, with $3,000, I wouldn’t bother with any of this.
But if you’re 55 or 65, or your folks are, this might be a place for a portion of your (or their) retirement money.
Now that the auction is over, you will probably have to pay a bit more to your broker to buy them in the secondary market. When I called to get a quote for you yesterday, my full-service broker offered them at $99.25. (Bond prices are quoted in ‘cents on the dollar,’ even though they are denominated in $1,000’s. At $99.25, each bond would cost you $992.50.)
It’s not that they had jumped nearly a dollar each, from $98.31 to $99.25. It’s that the firm was marking them up a about dollar – an extra $10 a bond. Had I been in the market to buy $1 million worth, this would have yielded my broker and his firm $5,000 each. I wasn’t in the market to buy $1 million worth, sadly, and you may not be either. But in any event, if you get the bonds for anything ‘under par’ – less than $1,000 each – I wouldn’t obsess too terribly over the spread your broker takes. Over 30 years, it won’t amount to much. (If you sell before maturity, you can expect your broker to lighten your proceeds by at least as much again, if not more.)
TIPS are no way to get rich, but a pretty good way, inside a retirement account, to hang on to what you have.
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