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Where is the best place to buy TIPS and other Treasury Securities?
-- John Privat, Rayne, Louisiana
Funny, isn't it, how suddenly everyone's interested in bonds. Why a couple of years ago, when buying bonds would have been one of the best plays around, the conventional wisdom held that only widows and wimps had any business in bonds. My, how times have changed.
Okay, enough ranting on my part. Let's get to your question.
First, for the uninitiated, a quick explanation of TIPS, or Treasury Inflation-Protected Securities. Unlike regular Treasury bonds (and virtually all other bonds for that matter) TIPS pay a guaranteed real rate of return -- that is, a return guaranteed to stay ahead of inflation by a specific margin.
In May 2003, they were yielding a little less than 2 percent for a 10-year bond. That might not sound like much, but remember, this is a real rate -- that is, nearly two percentage points above inflation.
Every six months, the principal value of TIPS are adjusted upward to keep pace with inflation.
Assuming inflation doesn't go away, both the face value and the income from TIPs rise with inflation over time.
So you get the security of principal of a regular Treasury bill, plus protection against inflation.
How can I get some?
So how can you buy TIPS as well as regular Treasuries? Well, the most inexpensive way is to buy from your uncle in the bond business -- Uncle Sam. The U.S. Treasury department holds auctions for TIPS and regular Treasury bonds at various times throughout the year, and during those times individuals can buy TIPS or regular Treasuries directly from the Treasury in amounts as small as $1,000. For auction dates as well as information on how to buy directly from the government, check out the Treasury Direct site.
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You can also buy TIPS and regular Treasuries through mutual funds. Several fund families, including Fidelity, Pimco and Vanguard, offer TIP funds, and virtually all fund families offer funds that invest in a variety of government bonds.
(You can find such funds by going to our Fund Screener, although you should be aware that most government bond funds don't limit themselves exclusively to Treasuries. If you screen for government bonds on our Fund Screener and then click on the fund's ticker symbol, you'll find links that can give you more information about the types of bonds the fund owns.)
Watch out for taxes
The income from TIPs, like that from other Treasuries, is exempt from state and local taxes. But TIPS also have a tax disadvantage: the inflation-adjustments to principal are taxed each year even though you don't actually receive that gain until the bond matures. So you should consider holding TIPs in a tax-deferred account like an IRA, if possible.
One final note: there is also an inflation-adjusted version of U.S. Savings Bonds called I Bonds, which also pay a guaranteed real rate of return. I Bonds currently pay a slightly lower rate of interest than TIPS, but they have other advantages that can make them appealing.
Your interest payments are added to the bond's principal value rather than paid to you directly, so you pay no tax on that return until you actually redeem the bond. And if you use I Bonds to pay for education expenses, you may be able to avoid taxes on the I Bond's interest and principal gains. For more details on I Bonds, click here.
Who knows, maybe when the stock market gets back to cruising speed again -- and, believe me, it will eventually, although I haven't the foggiest idea when that will happen -- people will remember how bonds performed during the past two years and be less apt to ignore them during the next bull market. But I wouldn't count on it.
Walter Updegrave is the author of Investing for the Financially Challenged and can be seen regularly Monday mornings at 8:40 am on CNNfn.
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