Money Manager Likes Inflation Index Treasury Bonds

- Alan Lavine and Gail Liberman

"With inflation at 4 percent annually, the purchasing power of the dollars returned at maturity on a five-year bond is over 20 percent less than the purchasing power of the dollars invested," warns John Pak, former manager of the Turner Short Duration Bond Fund. A bond's regular interest payments may not be enough to offset this.

Pak, now a Walnut Creek, Calif.-based money manager, suggests Treasury Inflation Protection Securities could be your answer. Reason: The principal value of the bonds should rise with the inflation rate--a feature that makes them attractive long-term investments. When the bonds mature, your purchasing power should be preserved. In addition, the bonds are guaranteed by the full faith and credit of Uncle Sam.

There is no free lunch with TIPS. Unless you keep them in a tax-deferred retirement savings account, you will pay income tax on the increase in the value of the bonds. In addition, if you must sell the bonds before they mature, you could take a beating due to rising interest rates and/or low inflation.

Pak says your best bet is to buy and hold TIPS in your retirement accounts until they mature in either five years, 10 years or 25 years.

"Longer maturity TIPS should represent about 10 percent to 30 percent of your tax deferred retirement savings," he suggests. "They are unique in their ability to provide liquidity and inflation protection. Other investments that protect against inflation, such as commodities and real estate, are quite illiquid."

You can buy individual TIPS through a brokerage firm. Mutual funds, including American Century and the Vanguard Group, also have inflation-indexed bond funds, which invest in TIPS. Be advised, however, that bond funds never mature. The net asset value of the funds will always fluctuate.

Note that there has been some speculation that the index used to adjust the principal value of TIPS could be adjusted downward, cutting returns.

#

Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).