Financial Literacy - Financial Tuneup
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Building blocks for successful investing

TIPS

Issued by the government, Treasury Inflation-Protected Securities adjust with inflation as measured by the consumer price index. "Part of the return on a TIP government bond is the interest that they earn. But they will also increase the underlying value of the bond when inflation increases so you get not only the interest income, but also the value of the bond increasing periodically when inflation increases," says William M. Howell, CFP, CPA of Howell Financial Advisors Inc., in Noblesville, Ind.

TIPS pay a fixed interest rate, though the principal adjusts every six months with inflation. Although the value of the investment can go down, at maturity investors are paid either the greater of the adjusted principle or the original investment amount.

Available to individual investors directly, TIPS can be purchased through TreasuryDirect.gov, banks or brokers. They can also be bought through mutual funds.

"There are certain mutual funds, no-load, that concentrate solely on the TIPS market," says Howell. "You can go out and buy individual TIPS if you like, but I prefer to use a mutual fund manager to do that for me. They have more of an idea with their analysts and their background and specialty for that particular slice of the fixed-income market."

Advantages and disadvantages of TIPS
Pro
  • "It keeps abreast of inflation and is a stabilizer for a portfolio. It's a guaranteed low-risk investment. I think it's a great vehicle for everybody's portfolio," says Brosious.

Con
  • In a deflating economy, or a recession, the return on TIPS will be even lower, which in the best of times is less than the returns of other bonds.

REITs

The National Association of Real Estate Investment Trusts defines REITs as companies which own or operate income-generating commercial real estate. The structure of the company allows investors to buy into real estate the same way they could purchase a mutual fund. In order to qualify as a REIT, the company must derive a certain portion of its income from real estate and provide 90 percent of its earnings to shareholders every year.

REITs hold all kinds of real estate-related holdings. "Sometimes people get confused and think they are all the same," says Kinder. Some hold mortgage loans or they can be apartment buildings, shopping malls, warehouses or even timberlands, he says.

Advantages and disadvantages of REITs
Pros
  • According to Kinder, because REITs provide 90 percent of their earnings to their shareholders every year, they avoid taxation at the corporate level and pass basically all of their earnings on to the shareholders.
  • Commonly used as a tool for diversifying within a portfolio, REITs and other asset classes, such as commodities and natural resources, have a low correlation to the stock market. "Noncorrelating means that returns don't move in the same direction all the time. That tends to smooth out your portfolio earnings," says Brosious.
  • Actively managed funds, index funds and ETFs enable investors to get exposure to the real estate market.

Con
  • "They aren't tax-efficient because they do pay a higher dividend," says Kinder. Plus, these dividends are taxed at ordinary rates. "It doesn't get the 15 percent dividend pass that stocks do. So if you hold it in a taxable account it can hurt you as opposed to an IRA or a 401(k)," says Kinder.

 

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