Inflation bonds 101

When an investor, financial institution, mutual fund or foreign Government seeks inflation protection, it is a good idea enter into one or more of several financial vehicles designed to protect financial interests and worth. One such financial instrument is the inflation bond.

• What is an Inflation Bond: An inflation bond protects against inflation by offering an interest over and above a periodically adjusted inflation rate.

• Where you can find Inflation Bonds: U.S. Government inflation bonds can be bought directly from the department of the treasury, bureau of public debt. (http://www.publicdebt.treas.gov/) and foreign inflation bonds such as the Canadian Real Return Bond can be purchased through brokerage firms.

• Benefits of Inflation Bonds: Inflation bonds can do more than protect against inflation. Inflation bonds can also help one diversify an investment portfolio against adverse economic and market conditions. Additionally, since interest is not paid until maturity or redemption, inflation bonds can be utilized as an untaxed retirement savings vehicle. When they expire and/or are redeemed the owner may benefit from being in a lower tax bracket than at the time of purchase.

• Costs of Inflation Bonds: Government Inflation Bonds come in a number of different denominations and generally the amount one pays for them is the face value of that denomination. Corporate inflation bonds can be purchased either through a broker or directly form a company.

Tips on buying inflation bonds

When buying inflation bonds there are several things worth thinking about as in many forms of investing. Essentially those things revolve around finding the best deal with the least amount of risk. Some of the factors to consider are as follows:

• Bond Grade: Investment grade is an important indicator of the financial credibility of the institution(s) issuing the bond. The closer the rating is to AAA, the more accountable the issuer is.

• Secured Versus Unsecured: Collateralized bonds may not always be what they are cracked up to be. For example, secured AAA bonds backed by mortgage securities can decline in credibility if the housing market experiences a downturn. Unsecured bonds or 'debentures' rely on credit alone making the grade even more important.

• Real Rate of Return: The real rate of return is the actual amount of interest after inflation is deducted. Not all inflation bonds offer the same real rate of return. Shopping around can assist in finding the best rate.

• Rate Adjustments: Government I-bonds typically readjust interest rates every 6 months. It is a good idea to investigate how corporations readjust for inflation before purchasing their bonds.

• Foreign Inflation Hedge: If one lives in a country where inflation is high, investing in U.S. I-Bonds, Treasury Inflation Protected Securities (TIPS) and/or Corporate Inflation bonds may be a wise choice to protect ones income from losing value. Additionally, such investments can earn money in lieu of a less secure foreign savings vehicle.

Inflation Bonds are an attractive choice for both individuals and institutions wishing to protect, secure, diversify and stabilize investment capital and/or investment portfolios. While the returns on these types of bonds are not always as high as some other possible choices of investment, they do provide a consistent source of capital growth. Such capital growth can also be tax deferred in the case of I-Bonds, and interest gained from TIPS is both state and locally tax free.