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Published October 28th, 2009
Some "Tips" about TIPS!
By Lynn Ballou, EA, CFP

Are you nervous about inflation? Because of inflation concerns, TIPS, also known as Treasury Inflation Protected Securities, are in the news frequently as a potential solution for the inflation or interest sensitive investor.
Let's talk about some reasons TIPS are a hot topic and learn more about how they really work.
1) What are TIPS? TIPS are a type of investment issued by the US Treasury whose payouts adjust with inflation and deflation. These payout adjustments are done semi-annually, and it's not the stated interest rate of TIPS that is adjusted, but rather the underlying PRINCIPAL. So if I buy, let's say, a $1000 TIPS with a 2% interest rate, and then CPI increase by 3%, my underlying adjusted principal is now $1030 and thus the interest I receive will be $1030 times 2% instead of $1000 times 2%. This is why TIPS are of great interest to investors vulnerable to CPI volatility, especially retirees on a fixed income. The most important benefit of TIPS is the protection from the risks of unexpected and unknown inflation.
2) Tax Treatment: Investors receive some of the same tax benefits from TIPS that also come from Treasuries --- the interest income earned is state and local tax free. HOWEVER, and this is a big turn off for some: you will also receive a 1099 on any INCREASES in your principal each year (see #1 above) and they are TAXABLE each year even if you continue to hold them. So if you are a TIPS investor put money aside for that!
3) Liquidity Issues: TIPS are very liquid and trade daily in the secondary market. You do NOT have to hold them to maturity. So if you want out early, you can get out fairly easily. Unlike many other fixed income investments, their trading range has historically been much less volatile because they adjust regularly to inflation. However, remember that past performance is no guarantee of future results.
4) Valuation doesn't always rise: Guess what? Unlikely though it seems now, TIPS also adjust DOWNWARD for deflation ---- you may remember that this was a big concern earlier this year! Your interest RATE won't change, but if the underlying value changes, you can receive less income and if you sell during a deflationary period in the open market, you could receive less back from that sale than you paid for your TIPS. Good news: If you hold them to maturity you will receive either the adjusted principal or the original principal, whichever is greater.
5) How to Purchase: TIPS are issued in 5, 10 and 20 year terms with a stated interest rate. You can buy them from your investment advisor, some banks and you can buy them direct through the Treasury Direct program. They aren't issued daily, so if you want one immediately, you might prefer being a buyer in the secondary market of an existing issue.
TIPS are backed by the full faith and credit of the US Government as to timely payment of principal and interest and, if held to maturity, offer a fixed rate of return. If redeemed prior to maturity you may receive back less than your initial investment. A great website for investors interested in learning more about TIPS is the Treasury Director Research Center Website as follows: http://www.treasurydirect.gov and then search for information on "TIPS." For the right investor, and especially in these historic times, they could be a truly advantageous asset!

Lynn Ballou is a Certified Financial Planner (CFP) and co-owner of Ballou Plum Wealth Advisors, LLC, a Registered Investment Advisory (RIA) firm in Lafayette. Lynn is also a Registered Principal and Branch Manager with LPL Financial (LPL). As such, she is required by securities regulations to add the following information to this column: The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendation for any individual. Securities offered through LPL Financial, member FINRA/SIPC. Reach Lynn Ballou at lynn@ballouplum.com
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