Use Treasury Inflation-protected Securities

Physician's Money Digest, January 2007, Volume 14, Issue 1

With the housingmarket tumblingand oil prices finallydropping, it's nowonder that manyphysician-investors are looking formore stable investments to help theirportfolios weather the fluctuating markets.An uncertain economy alwaysmakes fixed-income securities a veryattractive option, especially since therisk of losing the value of your money inthis type of vehicle due to inflation wasquelled in 1997 when the first TreasuryInflation-protected Security (TIPS) wasissued. TIPS are government-issued debtsecurities, similar to savings bonds, and,as their name suggests, they are built toprovide inflation protection.

Make the Most of TIPS

The value of the security is based onthe Consumer Price Index (CPI), whichwill fluctuate according to inflation.The worth of TIPS is elevated by CPIcomputations to match the originalpurchasing power of your investment.Based on that adjusted value of thesecurity, interest payments are calculatedand paid every 6 months.

Since individual TIPS are expensive(ie, purchased in $1000 denominations),buying through mutual fundscan be beneficial in terms of cost anddiversification. If you are able to managethe price tag, however, individualTIPS guarantee you will not losemoney—or your money's final purchasingpower—due to a fickle economywhile the security matures. But beaware that if you decide to sell yourTIPS before maturity, Treasury Directsends out a request for bids and sellsyour TIPS to the highest bidder, whosebuying offer may not equal the valueof your initial investment. You could,therefore, lose money by selling yourTIPS early since the selling price isdetermined by what brokers are willingto spend. This gamble shouldprompt investors to hold onto theirTIPS for the long haul.

Acquiring TIPS is done throughyour broker or through Treasury Directat their Web site (www.treasurydirect.gov/indiv/myaccount/sectdes.htm),by phone (800-722-2678), or throughmail. In order to follow your TIPS, twostatements are sent to you per year:1099-INT, which shows the interestpaid, and a 1099-OID, which showsthe increase or decrease of your investmentdue to the CPI. Treasury Direct'sWeb site even lets you view both formsand an up-to-date record of taxabletransactions, or you can order duplicateforms by calling their 800 number.

What's the Catch?

As with all investment vehicles, thegood comes with the bad. AlthoughTIPS are exempt from state and localincome taxes, they are subject to yearlyfederal income taxes. With each hike ininflation, the value—and taxes—ofyour TIPS increases. Therefore, it isimportant for TIPS investors to realizethat for each year the TIPS are held, theinvestor is required to pay federal incometaxes on that growth even thoughthey won't receive that money until thesecurity matures.

Because of this obligation, it's best tohold TIPS in a tax-deferred account likean IRA. Keep in mind that since theprincipal, not the interest rate, is adjustedfor inflation, the purchasing poweronly remains constant before taxes.Taxes on the adjusted value diminishthe final purchasing power at maturitybecause tax percentages remain constantwhile money left after taxes hasweakened purchasing power the higherinflation rises. To understand moreabout TIPS and determine if youshould invest, visit the Treasury DirectWeb site or speak with your financialadvisor.