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Possibly the Most Popular Inflation Protected Investment

Image by Gerd Altmann from Pixabay

If you work in the United States, you are privileged to be participating in what is probably the most popular inflation protected investment and that is: Social Security.

When you are considering your inflation protected savings, make sure to take Social Security into account. We are told that for most retirees today, this is the largest source of income they have and it would appear that this trend will continue for most of us as we move into retirement as well.

Raises for Retirees?

For retirees, it may come as a pleasant surprise that their benefits go up from time to time. It probably feels like they are getting an raise, but that’s really not the case at all. What’s actually happening is that Social Security is linked to an inflation index. When that index signals that inflation has happened, you are entitled to an increase in benefits to make up for it. You are not getting any more real value. It’s just a way to make sure that your money continues to have the proper amount of buying power based on changes in what the dollar can buy. Another way to put it is that you are merely able to continue to pay your bills as they go up over time.

An Important Planning Consideration

As we are considering our long-term savings, it’s important to include Social Security in the mix. It is likely that most of our income will be coming from this program when we retire. In order to determine how much income we will need in retirement from other inflation protected sources, we really should consider what Social Security will already be covering in order to get an accurate picture.

When we are planning for retirement, it is helpful to know how much money we actually need to live on first. That’s the amount of money that you must have to pay all of your bills. Since these costs go up and they are not something that you can decide to stop paying, the income for them must go up too, even when you don’t work anymore. If your Social Security income isn’t enough to pay for your needs, it would be nice to know that now before you retire, otherwise you may think you have enough money to retire when you actually don’t.

Getting an Estimate

It’s extremely easy to get an estimate in order to help you with your retirement planning. The Social Security website has a calculator you can use called: The Retirement Estimator. It allows you to enter your Social Security Number and the amount of money you earned in the last year, then it uses the information as well as your income history from tax records to determine what you can expect to be paid each month at various dates of retirement. You can then take this information and compare it to how much your bills are today. That difference is the amount of income you will need to come up with in order to retire safely.

If you find that you are lacking enough money to live on, it means that you will need to keep saving now so that you can make up the difference. This amount should also be inflation protected so that you can keep up with your bills when you stop working.

If you find that you already have enough to live on based on your Social Security estimate, then you should probably consider what you can do to invest your money instead of merely saving it. That means that you probably don’t need to be as careful to have guarantees of inflation protection but may take a bit more risk since you probably won’t have to cash out your investments at a particular point in time to pay bills.

An Important Inflation-Protected Investment to Consider

When you use the Social Security Estimator. You will find that it gives you different numbers based on when you start taking your Social Security benefits. At the time of this post, it usually gives you three. One for early retirement, one for on-time retirement and one for waiting for maximum retirement age of 70. You will notice that there is a dramatic difference between taking your income early compared to waiting until you are 70 and this illustrates what might be the most simple and beneficial inflation protected investments a person can have.

It is estimated that by waiting to receive your benefits, you automatically receive an 8 percent increase in payout per year. You might be able to beat this on the stock market, but then again you might not. This may be the highest-paying, guaranteed, inflation protected investment we have, and it’s available to everyone if they will only wait to receive their benefits. It only works up to age 70, though, and then you might as well take the benefits because they don’t go up anymore.

The Good News

The great news about this investment is that you don’t have to do anything more than you are already doing in order to participate. Just keep working hard. In fact, your estimated income usually goes up when you earn more.

Second, since you already have Social Security, you are off to a great with your inflation protected savings.

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A Great Place to Start Investing

If you have loans, it may be the most overlooked place to invest other than TIPS.  In fact, I recommend investing in paying off the house you live in before investing in TIPS.  Your house is naturally inflation protected because it is a physical item that changes in price with inflation.  Not only that, you can actually make a lot of money by paying off your mortgage fast.

I developed a calculator to illustrate this.  I have used this calculator to save thousands on my loans.

 

Special Features

This is an investment like few others in that it has features that are difficult to get from a mere investment professional, including:
  • A guaranteed return on investment
  • Tax-free return
  • May actually reduce your existing risk
  • Inflation protection in certain circumstances
  • Increases cashflow
  • Emotional returns
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Possibly the Perfect Place for Emergency Savings

treasure boxIf you have established a habit of saving and have built up a decent amount of cash, you may start to wonder if there is a way to hold your savings somewhere that won’t leave you exposed to inflation.  There are those who advise you to invest that money, but that’s not really a good idea.  This is the money you intend to use when the unexpected happens.  This means that it can’t be locked up in an investment.  It has to be accessible immediately.  Wouldn’t it be nice if there was an investment that would allow your emergency savings to grow with inflation, but still allow you access that money during an emergency?  It takes a little planning and patience, but there is a way.

Beneficial Features of I Bonds

If you are a “United States person,” you can put your emergency savings in I Bonds.  United States Series I Savings Bonds have some unique features that make them especially attractive for this purpose:

  • I Bond interest is linked to inflation
  • They can be purchased online
  • They can be purchased in small or larger amounts
  • They can be sold anytime after a one year period
  • They keep earning interest for up to 30 years
  • Interest is state-tax free
  • Interest is federal tax deferred

This means that if you start moving a small portion of your emergency savings into I Bonds each year, you could eventually have it all moved over.  Once your entire reserve is in I Bonds, and a year has passed since the final purchase, you can take that money out if you ever have an emergency.  If you don’t it will earn interested at whatever rate necessary to keep up with inflation.

How to Do It

Here’s a scenario that you might adapt to your own situation.  Let’s say that you have a $3000 emergency fund sitting in a money market account at the bank.

First of all, you need to open your account with the United States Treasury.  I have step-by-step instructions on how to do that here.

Then, I would suggest that you save an extra $300.  You would now have $3,300 in emergency savings.  That’s $300 too much.  Take that extra $300 and buy an I Bond.

After a year passes, that bond will be available as emergency savings only it is now probably worth more than $300 because of the inflation adjustments.  Now you are $300 too high in your emergency savings fund again.  This time take $300 out of your money market account and buy an I bond.  Wait for another year.  Now you have over $600 in I bonds and $2,700 in your money market account.  Keep moving $300 each year until all of your emergency savings is in I Bonds.

The Tax Advantages

One of the great things about doing this is that, unlike a money market account, you are not taxed at the local level, and all of your federal taxes are deferred.  You only pay taxes on a savings bond when you cash it out.  This is especially attractive when you find yourself in an emergency.

If your emergency happens to be the loss of a job and you are forced to cash some I Bonds, you will probably be doing it at a lower tax rate.   This may also true if you end up needing it while you are retired.  It’s actually better from a tax point-of-view to take money out of I Bonds when you have less income.

Important Details

If you have a lot of emergency savings, make sure that you don’t attempt to buy more I bonds than you are allowed to buy.  Each person with a Social Security Number is allowed to buy up to $10,000 in I Bonds per year.  If there are two of you, you can both buy $10,000 as long as you both have an account set up.  You can learn more about these bonds in my article: I Just Want to Save My Money.

Another thing to understand, is that if you are forced to sell an I Bond between the second and fifth year after your purchase, you will lose two months of interest when you sell it.  Since you were already losing this money in your money market account, it’s not a big price to pay for protection.  You still get all of your original principal back. After 5 years, all of the interest is yours, no matter when you cash out.

The Next Step

Since you have already proven that you have the discipline to save, you might as well take the next step and start the process of inflation protecting your emergency savings.

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How to Calculate a TIPS Inflation Adjustment

Calculator Pen TabletTreasury Inflation Protected Securities (TIPS) have the properties of a bond.  Since bonds are just a kind of loan, we can expect to get our money back when the loan period is over.  What makes TIPS especially attractive, however, is that the principal value is adjusted for inflation over time.  This eliminates a bond’s worst enemy.  This valuable feature does have a drawback, though.  There’s more complexity in determining what the value of a TIPS bond is.  Not only are there two ways to consider the value as I discuss in the article: Two Ways to Look at TIPS, the value of the principal is constantly changing.

If you’re a saver like me, you are probably interested in the current value of the principal of your TIPS.  In order to determine that, we need to adjust the bond’s face value by all of the inflation that has been experienced up to now.

Adjusted Principal

The adjusted principal of a TIPS is the amount of money that you would receive if the bond were due today.  You can’t get that money today, but it is the what it would be worth if it were due.  For those of us with a strategy to hold the bond until maturity, this is a meaningful number.  It gives us a view into how much inflation we have been protected from so far.  It is also the number that indicates how much interest you will get on the next coupon.  If our coupon (interest) rate is 1%, that 1% is not calculated on the face value of the bond, but on the adjusted principal.  That means that your interest is going up with inflation too.

Three Step Overview

It’s actually pretty easy to calculate your TIPS current value.  The basic procedure is this:

  1. Get the CUSIP of your TIPS
  2. Go to TreasuryDirect and look up today’s inflation “index ratio” for your specific TIPS.
  3. Multiply the index ratio by the face value of your TIPS.

That’s really all you have to do.  If you hold several different TIPS with different CUSIP numbers, you will need to repeat this process for all of your CUSIP’s.

TIPS CUSIP’s

Every bond that is tracked by the public market has a special identifier called a CUSIP.   There are thousands and thousands of these but they each identify a single bond issue.  When you purchase a TIPS at your brokerage or online you will see your CUSIP for the bond on you “trade confirmation.”  For this example we are going to use the current 10 year TIPS CUSIP and that is: 9128283R9.  This bond was originally issued on 1/18/2018.

Finding your TIPS Index Ratio

Index Ratio Table at TreasuryDirectThe index ratio for a TIPS is a number that you multiply with the face value of your TIPS in order to determine it’s current real value.  TreasuryDirect keeps track of all of these numbers for every TIPS that is currently available on the market.  Every day there is a new index ratio for every bond.  You can look up the index ratios for your TIPS by going to this page on TreasuryDirect:

TIPS/CPI Data Page

When you open this page, you will see all of the CUSIP’s listed for every TIPS that hasn’t matured yet.  Then, you click on your CUSIP number.  When I click on the number 9128283R9, I get a list dates along with some other numbers in a table.  For the sake of my example, lets say that it is April 28th.  To get the Index Ratio, I would go down the list to 4/28/2018 and then go over to the Index Ratio column and see the number: 1.00897.  You will need to get this number for every TIPS that hold.

Calculating the Adjusted TIPS Value

The last step is easy.  For each one of your TIPS that you now have an Index Ratio for, you just take the total face value and multiply it by the Index Ratio.  That is you adjusted principal value.

For my example, let’s say that I have two TIPS bonds with the CUSIP 9128283R9 with an original face value of $1000.  My total face value for both is $2000.   Then multiply that by the Index Ratio I looked up: $2000 x 1.00897.  The resulting current value is: $2,017.94.  This tells me that my money is currently being protected from $17.94 of inflation.

If I had quite a few different TIPS with many different CUSIP’s, this might take a little while to do.  You can make it go a bit faster by getting my free TIPS Tracker Spreadsheet.   I hope to make this process much faster when the new software is released.

So, that’s how you do it.  It’s pretty neat to see your money go up in value, especially on days when the stock market is down.  I urge you to give it a try and experience it for yourself.


I have a spreadsheet that tracks your TIPS and helps you see your inflation protection in action. Learn more here

Copyright © Troy Taft 2018

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Two Ways to Look at TIPS

Thinking FrogTreasury Inflation Protected Securities (TIPS) protect investors from inflation by automatically adjusting the original face value of the bond for inflation.  What I have discovered is that this feature is used for different purposes by different people.  I tend to use TIPS as a method of saving principal, but there are those who use TIPS as a “hedge” against inflation within a larger portfolio of riskier investments.

The Saver’s View

I discovered that the way that I look at TIPS is much different than the way investors tend to look at them.  Since I look at TIPS as a way to save money for the future, I’m not very concerned about my returns.  I’m just trying to preserve the returns that I have already received.  I’m also trying to make sure that all of this money is available on a specific date.   I also intend for that money to be adjusted for inflation.

The Investor’s View

When investors use TIPS, they are usually trying to make sure that if there is a downturn in other investments that are sensitive to inflation, that they own something that counteracts inflation.  This allows their portfolio to lose less money or perhaps even gain money as a result.

Very Different Intentions

These two perspectives come from two very different intentions on the part of the bond holder.  One person is trying to preserve and the other is seeking opportunity.  This is why I recommend that you divide your money into two parts as I describe in the article: Stressed about Savings? Divide and Conquer!

The Investor’s Bond Market Focus

When we look at TIPS from the perspective of an investor, we are more concerned with counteracting inflation.  This can be done by trading bonds that are sensitive to inflation.  To TIPS traders, the current market value is more interesting than the adjusted principle.  An investor is less likely to hold a TIPS to maturity.  For TIPS investors, TIPS mutual funds or ETF’s may make sense.  Trading TIPS on the secondary market may also be useful.  Bond market traders are also very interested in Yield to Maturity (YTM).  That’s because they are concerned with the return on investment.  Without a good return, it isn’t a very good opportunity.  This may not be a big deal in some investor’s minds because the inflation protection may be worth a loss in that part of their portfolio, however.

The Saver’s Inflation Protection Focus

When we look at TIPS from the preservation of savings point of view,   we aren’t interested in the market value of TIPS.  We are interested in the adjusted principle.  Since we intend to be getting this principal someday when the bond matures, that’s all we really care about.  We are more interested in seeing how well our savings is being protected, rather than seeing our yield to maturity.  As preservers of principle, we are willing to pay some or even all of our yield to make sure that we have our money when we need it.

Taxes

Taxes are a serious problem for both the investor and the saver.  This is one place where the two views tend to come together.  Taxes can make it difficult for an investor by taking money away during a successful time causing the money to not be there for a time when things aren’t so successful.  This makes swings in income even worse.

For savers, taxes can actually cause us to lose money due to inflation as I explain in the article: “Inflation Protection and Taxes.”  Since we don’t make much interest on a savings style investment, taxation can make our preservation costs unpredictable and threaten our attempts to preserve once again.

Be Careful Not to Mix Views

It can really cause you to become paralyzed as to what to do with your money if you flip back and forth between the investing and savings views of looking at TIPS.  I find that it is wise to make a conscience effort to think one way or the other when choosing what to do.   I tend to use them for savings preservation.  I see very little help out there when it comes to looking at these bonds from this perspective.  By viewing TIPS in a way that matches your needs, you will be able to make more confident decisions with them.


I have a spreadsheet that tracks your TIPS and helps you see your inflation protection in action. Learn more here

Copyright © Troy Taft 2018