Finally, a Genuine Investment Tip
Gotten any good investment “tips” lately? You know the routine – you’re at a party, or perhaps simply filling your glass at the office water cooler – and a friend, coworker (maybe even a total stranger), offers you the latest sure-fire, can’t-miss investment tip. I suspect it’s happened to most of us at one time or another.
Whatever the motivation – human nature, charitable tendencies, the proliferation of celebrity personal finance “gurus” – the results are very often the same: disappointment at best, financial loss at worst. The simple – albeit, painful – truth of the matter is that there are just very few genuine investment tips. There’s a reason for this: markets are highly efficient. In layman’s terms, that means that by the time we receive the tip (“this stock is going to double in price when its earnings come out next month”), the market has already reacted to it, bidding the price up (or down) in anticipation of the event.
If most of us stopped to think about it for a moment, we’d see the folly in our logic: Is it possible that we are truly the first (or only) person to learn this information? Not likely. And if we were, it would almost certainly be as a result of material, non-public information (i.e. “insider” information) that only we were privy to. Trading on information of this sort is a criminal offense.
So, are there anygood, genuine investment tips? As it happens, yes, there are. And as a value-added service to those of you who are perusing this website, I’d like to share one with you. In fact, I’d like to give you “two tips for the price of one” – in a manner of speaking.
Let me start by saying that I am going to share an investment “tip” with you in the most literal sense – by describing a type of government security referred to by its acronym: TIP. TIP stands for “Treasury Inflation-Protected” Security, more commonly referred to in the plural form, as in “TIPS.” TIPS are bonds, issued by the U.S. Treasury. First issued in 1997, these bonds pay a fixed rate of interest semi-annually. Unlike conventional Treasury bonds, however (in which the interest payment remains fixed throughout the life of the bond), the interest payments on TIPS are indexed to changes in the CPI-U and rise with increases in inflation – hence the moniker “inflation-protected.”
Assuming a general increase in inflation over time (a safe assumption) – TIPS are the only investment guaranteed to keep pace with inflation. Moreover, because they are backed by the “full faith and credit” of the U.S. Government, you are guaranteed not to lose money when investing in TIPS (assuming that you hold them until maturity and that the government doesn't default on its obligations). For risk-averse investors and/or those on fixed incomes striving to maintain their purchasing power, that’s one tough combination to beat!
The mechanism by which TIPS are adjusted each year for changes in the CPI-U gives rise to some nasty tax consequences, however. Twice each year, the principal value is adjusted to reflect changes in the index. Investors don’t receive the principal additions until the bonds mature, or until they are sold. In either case, they are treated (from a tax perspective) each year as if they had: Owners receive two 1099s each year – one for interest and one for principal. Fortunately, these tax consequences can be conveniently avoided by purchasing the TIPS inside of a retirement vehicle, like an IRA or an employer’s retirement plan (assuming your employer offers them as an investment option), where both the interest income and additions to principal are tax-deferred until withdrawal, allowing for greater compound growth.
This brings me to the second tip I promised. And this one’s a doozy! How would you like to deprive (legally) the IRS of its share of your TIPS income and capital appreciation tax? Alright, it’s a rhetorical question, I know. Here’s how it works: Buy the TIPS in your Roth IRA. Assuming you are eligible (MAGI less than $95,000 for single taxpayers, $150,000 for married) to establish a Roth IRA, once you meet the age (59 ½ or older) AND holding period requirements (Roth IRA opened for five years or more); ALL distributions (contributions and earnings) from a Roth IRA are tax-free. It’s like a marriage made in heaven: An investment guaranteed to keep pace with inflation (which is in turn guaranteed by Uncle Sam against loss), and income and capital appreciation free of income taxes.
Now that’s an investment “tip” you can take to the bank!
NOTE:The preceding information is for informational purposes only. It is not intended as a specific investment recommendation, nor should it be construed as appropriate for your particular financial situation. Consult with your financial advisor and/or tax accountant to determine which investments are appropriate for your consideration.
TIPS may be purchased directly from the Treasury through Treasury Direct or in the secondary market through a broker/dealer. TIPS purchased in the marketplace are susceptible to price swings based on prevailing investor sentiment and/or changes in current interest rates, among other factors.