Some tips on the best investments from the US Treasury
Q: I'm concerned about protecting my investments from inflation. What's the better investment: inflation-protected Series I Savings Bonds or the inflation-indexed Treasury securities called TIPS?
M.R., via e-mail
A: Both Series I Savings Bonds and Treasury Inflation Protected Securities, or TIPS, are issued by the US Treasury, so they're equally safe as investments in the opinion of Tom Adams, author of "Savings Bond Alert." In addition, he notes that both are free of state and local income taxes.
In most states, paper I bonds are available from most banks in denominations as small as $50. You can also invest in I bonds using an online account at www.treasurydirect.gov. They pay interest for 30 years. You can't redeem them before one year and there's a three-month interest penalty if redeemed before five years.
TIPS are also available through TreasuryDirect, but only on a handful of days each year when the Treasury issues new ones. Most brokerage firms will also help you buy and sell TIPS that have already been issued. The only TIPS denomination is $1,000, and they pay interest for five, 10, or 20 years. Rather than buying TIPS directly, you can also buy shares in a TIPS mutual fund or a TIPS exchange-traded fund.
Series I bonds pay a fixed base-rate set at the time of issue for the life of the bond, plus the current inflation rate, which is adjusted every six months based on the Consumer Price Index. TIPS also pay a fixed base-rate set at issue for the life of the bond. Rather than making inflation adjustments to the interest rate, however, the Treasury makes monthly inflation adjustments to the underlying value of TIPS. When inflation is below zero, a TIPS's value will drop.
Likewise, the value of TIPS is sensitive to market interest rates. Like all traditional bonds, the value of TIPS goes down when interest rates go up and vice versa. Series I bonds, on the other hand, like all other US Savings Bonds, can never lose value.
Income tax on the interest earned by I bonds can be deferred until you redeem the bond, a feature that TIPS don't have. In fact, says Mr. Adams, with TIPS, you have to pay income tax each year on the monthly principal adjustments even though you won't receive any money to pay the tax with until you cash in the bond.
Finally, the fixed base-rate is usually higher for TIPS than for I bonds. Nonetheless, Adams says that Series I Savings Bonds are the better investment if you want a guarantee that you can't lose money or if you need their tax advantages.
