At your finger TIPS: get a hold on high inflation rates with treasury inflation-protected securities

Entrepreneur, Oct, 2004 by Scott Bernard Nelson

IN THE WORLD OF INVESTING, TIPS ARE HOT. And they're about to get hotter. Treasury Inflation-Protected Securities, or TIPS, didn't exist eight years ago, and until this summer, they existed only in a single maturity. Some were predicting the death of TIPS altogether as recently as three years ago, with inflation low and Wall Street dragging its feet because unprofitable buy-and-holders were the only ones who seemed to want inflation indexing.

But these days, investors of all stripes are taking another look at TIPS. The amount of money devoted to the newfangled Treasuries has mushroomed in the past 18 months, and mutual funds devoted to inflation indexing began to sprout this year, too. With the market growing fast, pension funds and other large institutional investors are almost sure to follow.

Starting in October, all that new interest will have another outlet. TIPS will be available in five-year maturities. Until July, when 20-year TIPS arrived on the scene, the investments had been available in 10-year maturities only. Five-year notes now round out the package.

With traditional Treasury bills, bonds and notes, the interest and principal are fixed once you make the investment Not so with TIPS. In the case of inflation-protected Treasuries, the interest rate is fixed from the time of purchase, but the principal changes in line with the Consumer Price Index (CPI).

Say, for example, you earned 2 percent on $10,000 worth of TIPS in year one of an investment If the CPI increased 4 percent in that time, then the next year, you'd still earn 2 percent on your investment--but the interest would be calculated from a base of $10,400. If we entered into a period of high inflation, the principal amount would move rapidly higher and protect your purchasing power.

There's just one big problem with TIPS. The interest rate you have to accept to get inflation protection is substantially smaller than you'd find with traditional Treasuries. If the going rate on 10-year TIPS is 2.25 percent, and the rate on traditional Treasuries is 5 percent, inflation would have to average 2.75 percent over the next decade for you to come out ahead with inflation indexing.

Even so, it's worth considering TIPS for at least a portion of your fixed-income portfolio. Consider it a hedge against higher inflation, if nothing else.

Investors can buy TIPS in $1,000 increments at the same government auctions where normal Treasury bills and notes are sold. Go to www.publicdebt. treas.gov, or call (800) 722-2678 to open a TreasuryDirect account and learn more. Or you can invest in TIPS through one of the new inflation-protected mutual fiends.

SCOTT BERNARD NELSON is deputy business editor at The Oreganian and a freelance writer in Portland, Oregon