For those nearing retirement, and for those jittery about a volatile market, portfolio growth is less of a concern. What those with a low risk tolerance want is capital preservation. Capital preservation is a portfolio strategy that focuses more on keeping inflation from eroding one’s principal, and less on trying to coax growth from a portfolio. One way to help you add a little more capital preservation to your portfolio is to invest in inflation protected Treasury securities.
Using Treasury Bonds to Preserve Capital
TIPS and I-Bonds
US Treasury bonds are generally considered to be rather low risk. Even with the current fears related to a huge federal deficit, many believe that the U.S., with its very stable taxpayer base, will not default. As a result, bonds are often considered low risk additions to an investment portfolio that needs a little more safety. While the possibility of default is always present, many do not consider the U.S. government likely to do so.
Unfortunately, yields on bonds are rather low right now. In many cases, Treasury yields would be hard-pressed to keep up with inflation, much less beat it. Unless you get inflation protected securities specifically designed to keep pace with inflation. This is what TIPS and I-Bonds are.
TIPS and I-Bonds both have ties to Consumer Price Index. For I-Bonds, there is a variable rate portion — in addition to the fixed rate that applies until bond maturity — that changes every six months, based on what is happening with the CPI. With TIPS, the adjustment is made to the principal every six months, according to the inflation measured by the Consumer Price Index. You won’t get your increase in principal, though, until the bond matures.
Taxes on Earnings from TIPS and I-Bonds
Understand that you still have to pay taxes on earnings from TIPS and I-Bonds. With I-Bonds, though, you can defer reporting the interest until the bonds are redeemed. However, if you want to report the accumulated interest, you run the risk of paying when you are in a higher tax bracket.
TIPS, though, are different. You have to pay taxes on your earnings as you receive them. And, even though you don’t get the cash from principal adjustments made to keep pace with inflation, you still have to pay taxes on them. This means that you pay taxes on earnings — even though you do not have the cash in hand. You can offset this by holding TIPS in a tax advantaged retirement account; then you do not have to pay taxes on your earnings until you withdraw from your retirement plan.
Purchasing TIPS and I-Bonds
It is fairly easy to purchase inflation protected securities from Treasury Direct. You can set up an account, and then purchase according to the options available. Note that you cannot have TIPS issued in paper format; it’s all electronic. You can purchase I-Bonds with as little as $25, and TIPS with as little as $100.
If you are interested in preserving some of your capital, inflation protected securities can help. However, realize that the low yields, and the inflation adjustments, really won’t help you beat inflation — you’ll only keep pace. So, while your purchasing power is protected from great losses, you are unlikely to see it grow.
Interested in learning more about US Bonds? Check out this article about US Savings Bonds.