Strip Mining

Treasury strips make sense for the long haul

It sounds almost too good to be true: the safety of a U.S. Treasury bond coupled with the potential to keep up with the stock market’s gains. Yet that coupling of security and return is offered in something of a hybrid investment, called of all things a Treasury strip.

Normally, Treasury bonds act as a ticket to get regular income for a set investment. If you purchase a $1,000 bond with an annual coupon rate of 6%, you’d expect to get a $30 payment twice a year, constituting the $60 in interest you’d be entitled to. The thing that sets strips apart is the fact that bondholders agree to skip the biannual income payment. Instead, in a case roughly equivalent to this first example, they would put down $200 with the promise of receiving $1,000 at a time in the future, say 10 years or so.

“I see strips as a great way to save for a kid’s college education,” says Ladell Graham, president and chief investment of officer of Smith, Graham & Co., a fixed-income money management firm in Houston. “Instead of buying savings bonds, you might opt to purchase Treasury strips with a 13- or 14-year maturity when your son or daughter is three or four years old at 50 or 60 cents to the dollar.” Graham also says Treasury strips start to look really interesting when their yield rises to 6.75% and above, as they have during much of the first half of 1997. As of this writing, a 13-year strip yields 7%, and for $41.70, you receive $100 at maturity in 2010.

While we’d suggest looking at Treasury strips as a long-term investment, statistics show that they have the potential for sizable gains as well. Studies by Ryan Labs, a leading bond research firm in New York, show that the 15-year Treasury strip has about the same level of volatility as the S&P 500 stock index. Not only that, but the strip has the potential to provide total returns that can match the index.
Two things to keep in mind: strips are available only through your broker, so expect to pay a commission. Secondly, you’ll want to keep in mind that increases in the value of your strip are taxable while accrued.

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