Curtis Hesler's tips on TIPS

"In a new paradigm where we believe risk will become a paranoid obsession with investors, a few TIPS make sense for income," says long-standing advisory industry expert Curtis Hesler.

In his The Professional Timing Service, he highlights the role of Treasury Inflation-Protected Securities within a long-term investment portfolio and reviews two ways for investors to purchases these issues.

"You can buy them in your Treasury Direct account. If you don’t have a Treasury Direct account, you
can open one at www.treasurydirect.gov.

"The problem is that so far, you can’t open a retirement account - only an individual account. Go to the Treasury Direct Web site and bone up on all the details, especially if you are going to buy them online.

"TIPS work this way. They are U.S. government bonds issued by the Treasury. They are marketable in that you can sell them in the 'after' market. They come in terms of 5, 10, and 20 years. The interest rate on an issue is determined at auction, and they are sold in increments of $1,000.

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"The principal is adjusted for changes in the Consumer Price Index. If the CPI increases, the principal increases. If the CPI falls, the principal will be adjusted lower.

"As per the Treasury Direct Web site, 'The relationship between TIPS and the Consumer Price Index affects both the sum you are paid when your TIPS mature and the amount of interest that a TIPS pays you every six months. TIPS pay interest at a fixed rate.

'Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases. At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. This provision protects you against deflation.'

"The Web site has further instructions and information on how to go about buying them as well as some tools to calculate changes depending on changes in the CPI, etc.

"The subtle trick, of course, is use of the CPI and the shameful government manipulation of that number. It is not actually a measure of inflation in a true sense, but it is the guide the Treasury uses to value TIPS.

"Nevertheless, TIPS have proven a decent investment, especially considering that the risk is as low as you can find anywhere. Buying TIPS in your Treasury Direct account will give you the safest way to invest fixed income money.

"The term is longer than T-bills, but you are not locked into a set yield as you are with typical longer term bonds. As inflation rises, the CPI must rise as well to some extent, and the TIPS will reflect that in higher yield and augmented principal.

"There is an another way to buy TIPS, but you will assume some minor added risk. You can buy the iShares TIPS ETF (NYSE: TIP). The added risk is that this is an exchange-traded fund complete with all the complex workings that allow ETF’s to exist, and they are dependent on the fund managers to do their job.

"Nevertheless, this is not a bad way to go with a little money and I advise purchase at $106.00 or less. The indicated yield is about 5.8% at that price, and they are less risky than most equity investments these days.

"Inflation is a fact, and it will not be abated by the recession. That is because the world is bidding up the price of resources, regardless of our needs.

"The commodity bull is a function of the value of the U.S. dollar, which is eventually going to fall from its current level of 72.50 to at least 60.00 as measured by the U.S. Dollar Index. As the dollar falls, commodities will require more dollars to purchase. That is the gritty truth about inflation, pure and simple."