Readers seek tips on Treasury Inflation Protected Securities

Q: Not too long ago, I read about a Treasury security whose rates fluctuated in accordance with interest rates. I would like to save what I've accumulated in some way that reflects inflation changes. I'm 75, widowed, and not comfortable with risk.
P.S., Methuen, Mass.

A: You're probably referring to TIPS - Treasury Inflation Protected Securities. But this investment fluctuates according to the rate of inflation, not interest rates.

TIPS are issued and guaranteed by Uncle Sam and are free of state and local income taxes. They pay a fixed rate of interest twice a year on a principal amount that is adjusted to account for inflation. The idea is to keep you a step ahead of the ever-rising cost of living.

But since you're averse to risk, be sure that you can hold onto a TIPS until it matures, says Mike Boone, a certified financial planner at M.W. Boone & Associates, in Bellevue, Wash. Currently the US Treasury sells only 10-year notes. You can sell it before the maturity date. But it will be valued in relation to the current interest-rate environment rather than the one that existed when you bought the bond. For example, if you've bought a TIPS that's paying out a 3 percent return and try to sell it when new TIPS are priced at 5 percent, your bond will be discounted in value.

If this sounds too risky, Mr. Boone suggests another government-backed debt instrument that carries an inflation beater, a Series I Savings Bond. Like TIPS, it pays interest semiannually, but an I Bond can be cashed in at any time without risking principal.

You can buy either directly from the government (call 800-722-2678 for information, or log onto www.publicdebt.treas.gov).

Q: I'm investing for my retirement and feel that stocks are too risky. Are TIPS mutual funds a good idea for my IRA?
M.H.R., VIA E-MAIL

A: "TIPS probably make more sense than traditional bonds given that interest rates are likely to rise," says Louis Stanasolovich, a certified financial planner in Pittsburgh.

But owning a TIPS mutual fund is not the same as owning an individual TIPS, he says.

If you own a TIPS, you decide when to sell it. With a fund, someone else makes that call. So the risk level is a little higher because any given bond won't necessarily be held to maturity in a fund, and holding a bond to maturity is the only way to guarantee the return of principal.

Mr. Stanasolovich suggests you consider a "stable value" fund, which IRAs can now own. These funds likewise protect principal, with many yielding in the 3.5 percent range, he says. The custodian for your IRA should be able to scout the horizon for a suitable stable value investment.

If you choose to buy TIPS through a mutual fund, Mr. Stanasolovich suggests finding one that charges low fees, leaving as much of the interest payout to you as is possible.