Moderator Maria Bartiromo of CNBC asked the panel what investments we would avoid. My immediate reply was “bond bubble, bond bubble, bond bubble!” Liz Ann Sonders stopped short of using that same terminology, but called bonds a “fear trade.” She went further saying she saw a “tremendous amount of risk in fixed income.”  Sonders and I are on the same page. We believe that, as a result of the sharp losses in equities from late 2007 to early 2009, people have rushed headlong into bonds, which they associate with low risk. To my mind, an asset class with historically low volatility is not necessarily low risk if its valuation rises well outside its normal range.

Three key factors have to be present before I consider an investment to be a bubble. First, there’s a huge surge of funds into the area; it can’t be a bubble without money inflating it. Second, there are signs of all-time high prices. Finally, the risk/reward fundamentals don’t make sense.

So here’s my case for bonds being in bubble territory.  First, a tidal wave of dollars has come in. According to data from the Investment Company Institute, $404 billion flowed into bond funds in 2008 and 2009, more than the $401 billion that flowed in during the preceding eight years combined (2000-2007).

Second, when judged against history, bond prices are in nosebleed territory.  On Oct. 26, 2010, the U.S. government auctioned off two-year Treasuries at a +0.40% yield, the lowest yield ever.  As many readers know, a bond’s price rises when its yield falls, meaning those two-year Treasuries are at an all-time high price. According to Leuthold, a top-notch investment research firm, many other types of bonds (from short-term commercial paper to long-term Treasuries), were recently near their all-time highs.

Finally, the future performance of bonds is looking less bright. As I write, the 10-Year Treasury bond has a +2.5% interest rate, which means in exchange for $10,000 a bond owner receives $250 each year until receiving the original investment amount back a decade later. That’s a very low return. Furthermore, there’s precious little protection against inflation, a bond’s greatest enemy. Think of it this way: If inflation hits the U.S. Federal Reserve’s preferred average of 1.5%, it will gobble up at least three of every five dollars a 10-year bond owner receives.

What’s the takeaway for our community? African Americans don’t like to lose money, so we tend to be conservative investors. This is why I believe we have participated in the rush to bonds. But bonds are not cash and can lose money. In my opinion, they are poised to do just that over the next few years. If the bond weighting in your personal portfolio has grown, either due to falling stock market values or due to active shifts, I strongly encourage you to rebalance. At these prices, bonds carry more risk than you think.

Rather than approach one of the select investment banking firms the comptroller’s has relationships with, the city held an open invitation for firms to conduct the bond underwriting where firms were given cash flows and charged with developing a solution that provided the city with the best structure and greatest savings. “It was the ultimate level playing field,” says James Reynolds, Jr., CEO of Loop Capital (No. 1 on the BE Investment Banks list with $2.248 billion in lead issues). “We heard back very quickly, certainly within a couple of weeks that we were chosen to have the best structure for the city and they wanted to retain us to provide structuring on the bond deal.”

According to New York City Comptroller John C. Liu, Loop Capital Markets earned the underwriting deal on the strength of its proposal.  “I am especially pleased that the highest-evaluated proposal was submitted by a minority-owned firm, which was named co-book-running senior manager for the sale.  That would not have happened under the usual rotation of local managers,” said Liu in a statement. “This effort underscores the value of leveling the playing field with open competition, ensuring best price and service for our taxpayers.”

Reynolds says the transaction is a positive one – not just for Loop Capital, but for all minority owned firms looking to do business with the Big Apple. “New York City sent out a clear message that they are aware of the fact that talent and hard work come in lots of different sizes and shapes and they allow for the best ideas to move forward.”

Stocks
When you invest in stock, you buy ownership shares in a company — also known as equity shares. Your return on investment, or what you get back in relation to what you put in, depends on the success or failure of that company. If the company does well and makes money from the products or services it sells, you generally benefit from that success and your investment will grow. However if the company does poorly and experiences losses, you may also lose a part or all of your investment.

There are two main ways to make money with stocks:
Dividends: When publicly owned companies are profitable, they can choose to distribute some of those earnings to shareholders by paying a dividend. You can either take the dividends in cash or reinvest them to purchase more shares in the company.

Capital gains: When you sell a stock at a price higher than what you paid to buy it, you sell your shares at a profit. These profits are known as capital gains. In contrast, if you sell your stock for a lower price than you paid to buy it, you will have a capital loss.

Both dividends and capital gains depend on the success of the company — dividends as a result of the company’s earnings and capital gains based on investor demand for the stock. Demand normally reflects the prospects for the company’s future performance. Strong demand (good for you as an owner) means that many investors want to buy the stock you own and this tends to result in an increase in the stock’s share price. On the other hand, low or negative demand (bad for you as an owner) results when more investors want to sell rather than buy the stock and your shares may be worth less than you paid for them.

But demand is not the only thing that affects a stocks price. It is also affected by what’s happening in the stock market in general, which is in turn affected by the economy as a whole. For example, if interest rates go up and investors think they can make more money with something else like bonds for example, they might sell off their stock and the stock market as a whole is likely to drop in value, which in turn may affect the value of the investments you hold. Other factors, such as political uncertainty at home or abroad, energy or weather problems, or soaring corporate profits, also influence market performance.

The stock market runs in a cyclical pattern and as prices drop, at some point they will be low enough to attract investors again who believe they can make money when the market turns around. An influx of investors tends to make the market rise. Sometimes, the market moves from strength to weakness and back to strength in only a few months. Other times, this movement, which is known as a full market cycle can take years.

Remember, at the same time that the stock market is experiencing ups and downs, the bond market is fluctuating as well but usually in the opposite direction. That’s why asset allocation, or including different types of investments in your portfolio, is such an important strategy. Therefore, be sure to invest in several types of investments at the same time, so that some of your money will be in the category that’s doing well at any given time.

Up next, learn to speak the language of stocks.

P.S. Missed a segment? This info and so much more about investing can be found in my ebook Investing 101: Everything You Always Wanted to Know About Investing But Didn’t Know How to Ask, which is available in August. Visit the MYM store at www.MindingYourMoney.net/store.htm to order your copy or for more info.

Patricia Stallworth, CFP is the president of PS Worth, a financial planning and adviory firm, the founder of Wise, Wealthy Women, and the author of Minding Your Money. Visit www.psworth.com and download a free series on investing.

CDs are time deposits, designed to hatch a return of principle plus interest at a future date

Before you invest, take some time to understand all of your options beginning with the different types of investments and the characteristics of each. As I wrote last week, there are three basic types of investments – cash, stocks, and bonds. All other investments represent a variation of one or more of these basic types. This seven-part series explores each type in detail.

This week, we continue the discussion on Cash Investments.

Certificates of Deposit (CDs)

Most people tend to think of CDs as simple investments but they can get complicated. Not all CDs are created equal so it will be important to know the ins and outs of any CDs you may be considering. But first the basics.

Certificates of deposit are time deposits. When you choose a CD, the bank accepts your deposit for a fixed term—usually a preset period from six months to five years—and pays you interest until maturity. At the end of the term you can cash in your CD for the principal plus the interest you’ve earned, or you can roll your account balance over to a new CD at the current interest rate. If you cash in your CD before it matures, you’ll usually pay a penalty, typically forfeiting some of the interest you’ve earned.

In the past, each CD paid a fixed rate of interest over its term. But today you can also find variable rate CDs, sometimes called market rate CDs. With these accounts, the interest rate may rise and fall with changing market rates or be readjusted on a specific schedule. If the current rate is low, it may make sense to purchase a variable CD. That way, if interest rates rise, you won’t miss out on the rate increase. On the other hand, if you expect rates to fall in the future, it may make more sense to buy a fixed-rate CD to lock in the higher rate for a specific term.

One alternative to purchasing single CDs is to create a CD ladder by purchasing several with different terms. You might start by dividing the amount you plan to invest in CDs into four equal amounts and purchasing four CDs with varying terms—say three months, six months, nine months, and one year. As each CD matures, you replace it with a one-year CD, so you have an amount to cash in or reinvest on a regular schedule. If you use a longer ladder, so that your CDs mature on an annual basis instead of a quarterly one, you would never have all your money invested at the same rate, which would allow you to avoid locking in a large sum at a low rate.

In addition to regular CDs, whose terms are rarely longer than five years, banks may offer long-term, high-yield CDs that pay a much higher rate of interest for terms as long as 10 or 20 years. These CDs may be callable, which means that the bank has the right to terminate the CD and pay you back your principal plus the interest earned to that point. This usually happens if your CD is paying higher interest than CDs currently on the market, and it means you would have to reinvest your principal at a lower rate than your old one paid. However, unlike the bank, you don’t have the right to end a CD contract if the situation is reversed and your CD is paying less than the current market rates.

Aside from purchasing CDs directly from a bank, you can also purchase CDs from a stockbroker or other investment professional. Brokered CDs may have longer holding periods, be more complex, carry more risk, and include sales charges or fees. If the fee is modest and the CD is paying a higher rate than you could find on your own, you may come out ahead. But you should take the fee into account. Although most brokered CDs are bank products, some may be securities—and won’t be FDIC insured.

Also, if the bank issuing the CD is FDIC-insured and the CD is a bank product, remember your account value will only be insured up to $250,000, and you must be listed as the CD’s owner, otherwise if the bank fails, you could suffer a loss.

As with any investment, always ask. Don’t assume because you know what that makes me and you when you do. Up next, stocks.

Patricia Stallworth, CFP® and CDFA, is the president of PS Worth, a financial education company, the author of Minding Your Money, and the host of the Minding Your Money Minute™. Learn more by visiting MindingYourMoney.net.

Plan now, and you could crack open some golden nest eggs later.

A good plan is key to a successful investment program. The basis or foundation of your plan is your goals so begin by crafting a list that includes your goals, the amount you need, why you need it or the purpose, and the date you need it.

For example, if you have goals to buy a house and retire, your list may look something like this:

I have listed a short-term goal (buying a house) and a long-term goal (retirement) so I now have the basis for making some important investment decisions. I can decide how much risk I can afford to take and still accomplish my goals, and some appropriate categories of investments for each goal.

House Goal: I can’t afford to take any risk with this money because I will need it in a relatively short period of time (two years). Therefore, I can only choose investments that will preserve my principal such as CDs, money market funds, or Treasury bills.

Retirement Goal: I can afford to take considerably more risk with this money because I will not need it for a long period of time (15 years). And, I don’t need all of the money in one lump sum. My plan is to withdraw a set amount each year to supplement my pension and leave the rest invested.

Depending upon the return I earn on my money each year, I may only need to use a small amount of the principal because the rest will be made up from the interest I earn or income from my bonds. So, my goal is to earn as high a return as possible while still staying at a moderate risk level.

Therefore, I will invest a large portion of my money in growth investments like stocks and/or stock mutual funds, exchange-traded funds, and possibly bonds that will mature in 15 years or longer to provide income. (Note: A great Website to determine how long your money will last if you withdraw a set amount each year from money that is growing at different rates of return is http://www.calcxml.com/do/bud05). Based on these two goals alone, a first draft of my portfolio allocation could look something like this:

However, remember this is just a first draft and my final portfolio allocation could be very different based on answers to additional questions regarding my risk tolerance level, how much money I currently have available to invest, and how much I plan to invest monthly.

Once you understand your goals and the types of investments that might work best to accomplish them, the next step in the process is deciding if you will go it alone or work with a financial adviser. Tune in next week for Part 2. (Please click on investing terms for longer definitions.)

Patricia Stallworth, CFP® and CDFA, is the president of PS Worth, a financial education company, the author of Minding Your Money, and the host of the Minding Your Money Minute™. Learn more by visiting MindingYourMoney.net.

To answer that question, let’s take a side trip. While we are too far away from the end of the journey to get into real specifics, there are some things you can do now to make your journey smoother down the road. Since everybody on the journey is in a different place in their financial lives, let’s start with some basic strategies based on whether or not you have investments. In each case, gather the information then keep it handy for other stops along the journey.

If you have investments, make a list of all of your investments, what you paid for them, and their current value. Then determine:

1: If you are losing money, making money, or if the value is staying about the same? Making this determination will require you to open your statements and take a good look at them. If you are in the habit of just throwing those in a drawer or a cabinet, stop and really look at how your investments are doing. Contrary to popular belief, ignoring them will not make any issues go away.

2:  The type and category of each investment. The basic types include cash, stocks, and bonds. Some typical investment categories include CDs, money market accounts, municipal bonds, industry-based stocks, and mutual funds with various objectives. For example, identify the industry any stocks you have are in and the specific objective of each mutual fund such as international, small cap, or healthcare. The ultimate goal is to build a diversified portfolio that includes different types and categories of investments so that when one group is down there is the possibility that others might be up and the return on your portfolio can remain relatively stable. Believe or not, some people who are making money even in this down economy.

3: The goal that this investment is intended to fund, when the money will be needed, and if you are on track financially to meet the goal.

4: How you feel about each investment? Is it a keeper? If so, why? Do you want to sell it? If so, why? Do you need to do more information to make a decision? If so, what kind?

If you don’t have investments, complete the following statements:

• The main reason I don’t have any investments now is because…

• I fund vacations and other major purchases by…

• Others depend on my income (spouse, children, parents, etc) and …

• My level of interest in investing is …

• My overall job/income status is…

• I would purchase investments if…

(For more information on investment basics, click here to download Chapter 22 – Investing: Start With the Basics from the “27 Savvy Financial Strategies for Women.”)

While gathering this information may not lead to more money immediately, understanding your current situation and what might be holding you back from achieving financial security is VII (very important information).

Remember, the best way to predict the future is to take charge, take control, and then set out on the path to create it. And answering these questions provides you with a great starting point.

Patricia Stallworth, CFP® and CDFA, is the president of PS Worth, a financial education company, the author of Minding Your Money, and the host of the Minding Your Money Minute™. Learn more by visiting MindingYourMoney.net.

Emerging Market Bond Funds

The emerging markets of the world are natural places to look for growth. As more citizens of China, India, Russia, Brazil, and elsewhere continue to attain a middle-class standard of living, economic growth in these countries will soar. In 2009, for instance, while the U.S. struggled to get out of a recession, the Asian Development Bank reported that the region’s economy proved to be more resilient than expected in its response to the global financial crisis. The bank projected economic growth at a 3.9% pace for 2009 and 6.4% in 2010. This compares to the Federal Reserve’s U.S. forecasts of a contraction of -1% to -1.5% for 2009 and growth of 2.1% to 3.3% for 2010.

With such growth also possible in other developing markets around the world, participating investors are likely to prosper. Sure enough, Morningstar reports that emerging markets stock funds returned 10.51% per year for the past 10 years, through the third quarter of 2009, among the best of all mutual fund categories. By contrast, U.S. domestic stock funds returned a scant 2.46% a year. There is however, one catch. Emerging markets stock funds are volatile. In the crash year of 2008, this sector lost nearly 55% of its value, a far steeper loss than U.S. stock funds suffered.

So, how can you pocket profits while reducing risks? Mix your emerging markets stock funds with funds that hold bonds issued by emerging markets governments and companies. Over the past decade, emerging markets bond funds have posted annualized returns of 10.74%, slightly higher than their cousin stock funds. Emerging markets bond funds certainly have risks (they lost almost 25% in 1998 and nearly 18% in 2008) but they have not been nearly as volatile as the stock funds. “Ideally, you should hold both emerging markets stock funds and bond funds,” says Tom Idzorek, chief investment officer and director of research and product development at Chicago-based Ibbotson Associates, a Morningstar company.

“If you have an emerging markets stock fund and a bond fund, you are likely to have a smoother ride, long-term, than if you have only one type of fund.” However, he warns that investors shouldn’t load up on emerging markets stocks or bonds, expecting the high returns of recent years. “Perhaps 10% or even 5% of a diversified portfolio should be in the emerging markets,” he says.

Top-Performing Emerging Markets Bonds Funds*

*Based on total annualized 5-year returns, through 9/30/09 (click to enlarge)

Dividend-Producing Stocks

If only 5%-10% of your portfolio is allocated to emerging markets, you probably should hold stocks from the U.S. and other developed nations as well. In order to minimize exposure to a freefall like the one we all experienced in 2008, you might want to include dividend-paying stocks. “Look for companies that have enough net income to easily cover the interest on their debt and the dividends they pay to shareholders,” says Eugene Profit, who heads Profit Investment Management (No. 15 on the BE Asset Managers list with $900 million in assets under management). “Those companies have strong fundamentals so they are likely to hold up well in any type of economy.”

What’s more, current law calls for stock dividends to be taxed no higher than 15%, through 2010. (Bond interest, on the other hand, may be taxed as high as 35%.) Among Profit’s current holdings, he is especially upbeat on these dividend-paying stocks:

Verizon (VZ): This telecom giant, the largest wireless carrier in the U.S., now has a dividend yield over 6%. “The company may get the rights to sell [Apple’s] iPhone in the next year or two,” Profit says. “In the meantime, the high dividend means investors are being well-paid to wait for news that might boost its stock price.”

General Electric (GE): This company has been included in the financial sector because of its GE Capital subsidiary. As a result, its stock price has suffered in the credit crisis. “GE really is an industrial company, not a bank,” says Profit. “It is well-positioned to increase earnings as the economy recovers.” Meanwhile, it offers a well-covered 5% dividend yield.

United Parcel Service (UPS): Profit puts the current dividend yield at 3.25%, which is as high or higher than you’d get from most bank accounts or Treasury bonds. “In addition,” Profit says, “UPS has the highest profit margins of any major company in the transportation industry. So investors might see its stock price move up when the economy improves.”
·
Home Depot (HD): The home improvement retailer has a current yield of 3.40%. “Shelves look empty at Home Depot these days as homeowners launch do-it-yourself projects and hire contractors, either to help sell their homes or make them more comfortable because they’ll be there for awhile. Also, management is making an effort to be more customer-friendly,” says Profit of the company whose current dividend yield is around 3.4%.

Johnson & Johnson (JNJ): The healthcare company has a current yield of 3.2%. Profit admits that healthcare stocks have been up-and-down with all the talk of federal healthcare reform. “Once that’s resolved,” he says, “the basic fundamentals will emerge: an aging nation and an aging world mean more demand for healthcare.”

Overall, Profit suggests mixing high-dividend stocks with growth-oriented issues that pay little or no dividends. If you are getting an overall 2% to 3% yield from the stocks in your portfolio, you might have current income, upside potential, and downside protection if stocks slump again.

Wealth For Life Principles

1. I Will Live Within My Means
2. I Will Maximize My Income Potential Through Education and Training
3. I Will Effectively Manage My Budget, Credit, Debt, and Tax Obligations
4. I Will Save At Least 10% of My Income
5. I Will Use Homeownership as a Foundation For Building Wealth
6. I Will Devise An Investment Plan For My Retirement Needs And Childrens’ Education
7. I Will Ensure That My Entire Family Adheres To Sensible Money Management Principles
8. I Will Support the Creation and Growth of Minority-Owned Businesses
9. I Will Guarantee My Wealth Is Passed On To Future Generations Through Proper Insurance And Estate Planning
10. I Will Strengthen My Community Through Philanthropy

Peace of mind has been a luxury of late. We all know what happened to stocks in 2008. And while the equity market staged a rally early in 2009, many pundits say the upswing could be short-lived. Meanwhile, the Federal Reserve, has slashed interest rates in the name of buoying the economy––a move that has brought bond yields down to miniscule levels. And if that isn’t enough, many experts now believe the Obama administration’s efforts to save the economy could bring about a period of high inflation.

At first blush, TIPS seem to hold many answers.  As a bond, they offer stability––the promise to provide investors with steady amounts of income twice a year and return their principal after a specified period of time. What’s more, TIPS are issued by the Treasury Department and backed by the U.S. government, a debtor that despite recent deficit spending still enjoys a good reputation in the investment community.

TIPS aren’t the only inflation-fighting bond offered up by the Treasury.  I-Bonds, another offering, are pegged to the CPI as well, but offer investors less flexibility. TIPS are adjusted to CPI fluctuations monthly, whereas I-bonds are tweaked twice a year in May and November. TIPS can be bought and sold through a broker at any time; I-bonds must be redeemed and cannot be traded. I-bond holders pay a penalty if they opt out within the first five years.

Investing in TIPS is fairly straightforward. They come in five, 10, and 20 year maturities––that is, the number of years investors receive interest payments before their principal is returned. Investors can purchase TIPS directly from the government in $100 denominations at www.treasurydirect.com. Nonetheless, there are a couple of important caveats. One consideration is that TIPS income payments are taxed as income by the government, an assessment that can take a sizable chunk out of the bonds’ return.  As a result, financial advisers say a TIPS investment works best in a tax-deferred IRA or 401(k) account. Another factor to keep in mind is that during deflationary periods, a TIPS’ underlying value decreases in line with the CPI.  Lawrence Jones, an analyst with the Chicago investment research company Morningstar, says investors “don’t have to bet the house,” on TIPS. A 5% to 10% allocation in a personal portfolio makes sense.

Dawn Brown, senior financial adviser for the money management firm Altfest Personal Wealth Management, and other experts say there are a number of advantages to buying TIPS mutual funds rather than individual bonds. First, the mutual funds are actively managed by professionals who monitor the bond market and inflation trends and who can select the best times to buy and sell holdings. Fund managers hold many investments in a diversified portfolio, and by spreading money across a number of positions, they manage to take advantage of the most favorable market conditions and protect your investment from a downturn. Brown says, “Diversification and the expertise of a portfolio manager are clear advantages a mutual fund brings to what is a low-volatility investment.” According to Jones, “TIPS’ valuations can vary widely and individual investors can often be skittish and sell out at the wrong time. It pays to have someone experienced at the helm of a portfolio who can buy and sell at the best time.”

Mutual funds, of course, come at a price and annual fees are assessed on investor returns. Also, many of the better offerings require a minimum initial investment of $1,000 or more. Jones recommends shopping for funds with an expense ratio of 0.50% or lower.

HOT TIPS

Recommended Treasury Inflation-Protected Securities mutual funds:

Vanguard Inflation Protected Securities (VIPSX)

One-year yield: 3.79%

Expense ratio: 0.20%

Minimum investment: $3,000

Telephone: 800-662-7447

American Century (ACITX)

One-year yield: 4.37%

Expense ratio: 0.49%

Minimum investment: $2,500

Telephone: 800-345-2021

PIMCO Real Return D (PRRDX)

One-year yield: 2.29% yield

Expense ratio: 0.90%

Minimum investment: $1,000

Telephone: 800-426-0107

Source: Morningstar
This article originally appeared in the August 2009 issue of Black Enterprise magazine.

I’m happy to report that investors who’ve heeded the advise of Black Enterprise’s stock-picking experts for the first half of 2009 are experiencing higher gains than they would have if they’d invested in a fund that tracks the S&P 500 Index. In 2009’s first six issues of Black Enterprise magazine (which appeared in subscriber’s mailboxes between Dec. 12, 2008 and May 22, 2009), six financial experts touted 18 stocks (three each) as part of the magazine’s  “Stock Picks” feature. The entire group of stocks posted a total return of 9.13% through mid-July (measuring from the time of publication for each pick), compared with the S&P 500’s gain of 6.78% over the same period.

Of the experts who participated in Stock Picks ending with the June issue, Morningstar analyst Daniel Holland (featured in January) selected the best-performing basket of stocks, suggesting that readers look at industrial companies Watsco Inc., Emerson Electric, and Thomas & Betts. Those companies’ shares jumped a collective 24.24% through mid-July.

It’s no easy feat choosing winners in this environment, as I’m sure Ted Parrish, principal and director of investments at The Henssler Financial Group, can attest. For our June 2009 issue, Parrish picked three stocks (General Electric, iShares Dow Jones, and Stryker Corp.) that have, thus far, been the worst-performing group-of-three. They were down a total of 2.9% by mid-July. It’s important to remember, however, that BE’s Stock Picks are meant to be relatively long-term investment plays. So, keep watching.

We all know what happened to stocks in 2008. And while shares staged a rally early in 2009, many pundits say the upswing could be short-lived.  The Federal Reserve, meanwhile, has slashed interest rates in the name of buoying the economy, a move that has brought bond yields down to miniscule levels.  And if that isn’t enough, many experts now believe the Obama administration’s efforts to save the economy could bring about a period of high inflation.

At first blush, TIPS seem to hold many answers.  As a bond, they offer stability – the promise to provide investors with steady amounts of income twice a year and return their principle after a specified period of time. What’s more, TIPS are issued by the Treasury Department and backed by the U.S. government, a debtor that despite recent deficit spending still enjoys a good reputation in the investment community. To cap it all off, the initial invested principal holders put into TIPS rises and falls in value to keep pace with inflation as measured by the consumer price index or CPI.

TIPS aren’t the only inflation-fighting bond offered up by the Treasury.  I-bonds, another offering, are pegged to the CPI as well, but offer investors less flexibility.  TIPS are adjusted to CPI fluctuations monthly, whereas I-bonds are tweaked twice a year in May and November.  TIPS can be bought and sold through a broker at any time; I-bonds must be redeemed and cannot be traded.  I-bond holders pay a penalty if they opt out within the first five years.

Investing in TIPS is fairly straightforward.  They come in five-, 10- and 20-year maturities – that is, the number of years investors receive interest payments before their principal is returned.  Investors can purchase TIPS directly from the government in $100 denominations at Treasurydirect.gov. There are a couple of important caveats nonetheless.  One consideration is that TIPS income payments are taxed as income by the government, an assessment that can take a sizable chunk out of the bonds’ return.

As a result, financial advisers say a TIPS investment works best in a tax-deferred IRA or 401(k) account.  Another thing to keep in mind is that during deflationary periods, a TIPS’ underlying value decreases in line with the CPI.  Lawrence Jones, an analyst with the Chicago investment research company Morningstar, says while investors, “don’t have to bet the house,” on TIPS, a 5% to 10% allocation in a personal portfolio makes sense.

Brown and other experts say there are a number of advantages to buying TIPS mutual funds rather than individual bonds.  First, the mutual funds are actively managed by professionals who monitor the bond market and inflation trends and who can select the best times to buy and sell holdings.  Fund managers hold many investments in a diversified portfolio, and by spreading money across a number of positions, they manage to take advantage of the most favorable market conditions and protect your investment from a downturn.  “Diversification and the expertise of a portfolio manager are clear advantages a mutual fund brings to what is a low-volatility investment,”  says Dawn Brown, senior financial adviser for money management firm Altfest Personal Wealth Advisers.

According to Jones, “TIPS’ valuations can vary quite widely, and individual investors can often be skittish and sell out at the wrong time.  It pays to have someone experienced at the helm of a portfolio who can buy and sell at the best time.”

Mutual funds, of course, come at a price, and annual fees are assessed on investor returns.  Also, many of the better offerings require a minimum initial investment of $1000 or more.  Jones recommends shopping for funds with an expense ratio of 0.50% or lower.

HOT TIPS

Recommended Treasury Inflation-Protected Securities mutual funds:

Vanguard Inflation Protected Securities (VIPSX)

One-year yield: 3.79%

Expense ratio: 0.20%

Minimum investment: $3,000

Telephone:  800-662-7447

American Century (ACITX)

One-year yield: 4.37%

Expense ratio: 0.49%

Minimum investment: $2,500

Telephone: 800-345-2021

PIMCO Real Return D (PRRDX)

One-year yield: 2.29% yield

Expense ratio: 0.90%

Minimum investment: $1,000

Telephone: 800-426-0107

Source: Morningstar