If you are worried about inflation, add Treasury Inflation-Protected Securities (TIPS) to your portfolio.
* TIPS are issued by the federal government so they’re similar to all Treasury issues. They have virtually no risk of default and the interest income from TIPS is exempt from state and local income tax.
* TIPS offer both a fixed interest rate and variable principal, linked to inflation. If you buy TIPS with a 1 percent interest rate, for example, and inflation is 3 percent a year, your return from the TIPS at maturity will be 4 percent per year.
* The interest on TIPS is paid twice a year but the inflation-linked buildup is not paid until maturity. However, you’ll owe tax on TIPS each year, on both the interest you’ve received and the inflation-linked buildup you haven’t received.
* Some advisors suggest holding TIPS in an IRA, where the tax can be deferred until money is withdrawn.
* You can buy TIPS from the federal government, at no cost, by going to www.treasurydirect.gov.
* One tactic is to buy TIPS directly each year, at the 5- and 10-year auctions. This will permit you to construct a ladder of TIPS with different maturities. When TIPS mature, you can reinvest and earn higher yields, if interest rates have gone up.
