Treasury Inflation Protected Securities And Its Benefits
Posted on 26. May, 2010 by Global in Uncategorized
The government has created record in spending that include $108 trillion in unfunded liabilities for social security, Medicare plus another universal healthcare benefits. This has put the country on risk. With the rates of interest close to zero, the Federal Reserve are not able to take one conventional action – reducing short-term rates – to re-establish the weakened economy.
In this difficult economic slump or double-dip recession, politicians – with the reluctant help of the Fed – could decide to spend even more massively to attempt to jump-start the economy. The consequence could be stagflation: slow growth along with higher inflation.
Inflation is the curse to the debt holders. However it is a blessing to the debtors – and Uncle Sam is the chief of them – as they can pay the fixed obligations with increasingly worthless currency.
Are you scared of growing inflation? And want to make sure better returns over inflation from your investments at small amount of risk? Therefore Treasury Inflation Protected Securities (TIPS) may be the best investment option for everyone.
Treasury Inflation Protected Securities (TIPS) are also known as Treasury Inflation Index Securities and Real Return Bonds (RRB). TIPS are ‘safest of the safe’. There is least downside risk on investment. TIPS are long-term fixed income investments protected against fluctuations in the rate of inflation.
But why employ TIPS as your hedge against inflation, rather than a traditional hedge, such as precious metals? You can make use of both as your hedge against inflation. But always remember, precious metals like gold and silver are less than complete hedges.
Gold and silver have performed very well over the last 10 years. Gold has more than quadrupled. Silver has ended even better. But 20 years before that were a total disasters.
But no matter even if inflation is low or high, TIPS will safeguard you from the risk on your investment. How?
Here are the benefits of buying Inflation-Protected Treasuries:
Regular Interest Payments: Just similar to a regular Treasury bond, TIPS reimburse interest regularly once in six months. But unlike traditional bonds, your principal grows every year by the amount of inflation, as calculated by the consumer price index (CPI). That is when inflation rate is up; value of TIPS is also increased automatically. In other words, inflation protection is available on both capital and investment. The interest paid once in every six months as well escalate by the amount of inflation.
Tax Advantages: The interest you receive from TIPS investments are exempted from state and local income taxes (but not federal).
TIPS are also less volatile when compared to the traditional bonds. The yield on these TIPS funds is at present just about 2.5% (plus whatever inflation is going ahead).
Another main reason to consider adding TIPS to your portfolio is the great portfolio diversification benefits they bring. This reduces the total risk and / or volatility of your portfolio over time. TIPS bond yields are low or negative correlation with the performance of many other traditional investments such as stocks and regular bonds.
Growing inflation probability are beneficial for TIPS yield, however in the short term are negative for the returns of shares and bonds and vice versa.
TIPS can be purchased in 3 ways:
1. Directly: You are able to purchase TIPS directly from the U.S. Treasury or through a bank, broker, or dealer. You can find out more about buying TIPS directly at http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_buy.htm
2. Through the Vanguard Inflation-Protected Securities Fund (VIPSX).
3. Through its ETF equivalent – the iShares Barclays TIPS Bond Fund (NYSE: TIP)
Purchasing TIPS through mutual funds offer more flexibility.
various} benefits of buying TIPS
1. TIPS are very advantageous for long-term investments.
2. TIPS are superb ways to diversity your portfolio that minimizes whole portfolio risk.
3. TIPS are government guaranteed.
4. TIPS are less unstable than traditional bonds.
5. TIPS are advantageous when inflation rates are projected to go up also when economy slows down.
6. Investment on TIPS involves less active investment management therefore favor both newbies and skilled traders.
Some traders object that TIPS hasn’t done anything interesting in recent times. This is not true. We’ve been in the influence of disinflationary forces, not inflationary ones. That will not alter next week or next month.
But as the deficit continues growing which makes people sad, pressure will increase on the government to do “something”. That “something” could be a result to inflate our way out of this mess, rather than risk the kind of deflationary spiral that Japan has suffered over the past 2 decades.
Understand that:
- The Fed has already taken interest rates near to zero.
- Congress has by now tried a huge fiscal stimulus.
- The Federal Reserve has already created trillions out of thin air to mop up worthless securities.
There are chances of increase in inflation if the economy stumbles once more that forces to the government to take further action, it can be even further reckless.
Some libertarians and laissez-faire capitalists will refuse to purchase TIPS. But other inflation hedges sometimes don’t work. So there is no small risk taking another approach.
In total, TIPS is the only investment that guarantees a gain that exceeds inflation in the years to come. And it is in fact an vital element of your portfolio.
Hedging against inflation can be risky sometimes. Subscribe to the FREE Weekly Wealth Letter to learn strategies about Hedging against Inflation to reduce risk on your investment.
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