WILL

TREASURYS
RESCUE YOUR
PORTFOLIO?
By Nikhil Hutheesing

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008 was a pitiful year for investors but there was one group that had something to

boast about: those who bought Treasurys. During times of economic crisis and mar-

ket turmoil, investors often move into Treasurys, which are typically regarded as a safe-

haven for funds. While the broader stock market indexes were down about 40% in 2008, 10

year treasury notes, which are government securities that are issued with maturities of 2,

3, 5, and 10 years and pay interest every six months, saw their yields drop—from more than

4% to 2%—still providing income for investors. The yield on 30-year maturity Treasury

bonds, also known as the Long Bond, fell from 4.5% to 2.6% as the price jumped by 37.5%,

so with the interest coupon, the total return was 42%.

Is investing in Treasurys still wise? With the prospect of inflation, Obama’s massive

stimulus spending and an increasing deficit, you have to be very careful. Here’s what you

need to know and what you may want to buy.

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Treasury Notes and Bonds the market value. Treasury bond futures require
Gary Shilling, a Forbes columnist and one of even less margin, around 1%. Zero coupon
the nation's top economists and editor of Gary bonds, which are sold at a discount and have the
Shilling's Insight, has long been profiting from interest return built in since they mature at par,
Treasurys. Back in 1981 when 30 Year Treasury rise much more in price than coupon bonds
bonds peaked at 14.7%, Shilling recommended when interest rates fall. That's because you don't
buying Treasurys and he successfully remained have to reinvest the coupon payments at ever-
invested during the its 27 year rally. Treasury lower returns as interest rates fall.
bonds, like Treasury notes, pay interest every six But Shilling’s excellent track record would be
months, but the bonds mature in a period greater hard to replicate in today’s environment. So is
than 20 years. now a good time to get into Treasury bonds?
In his report, Bear Market Tool Kit, Shilling Probably not. Interest rates are very low and
explains why Treasury bonds can be so good investors know that President Obama is planning
for investors. to counter the bad news with an increase in stim-
ulus spending, which could mean a rise in infla-
◆ First, he says they're the best credits in the tion, along with an increase in the nation's debt.
world, so far above AAA that they aren't rated but
instead are the standard by which other fixed
income vehicles are compared. This means you TIPS May Be the Best Choice
don't have to worry about credit quality, defaults With the prospect of higher interest rates and
or writedowns as is the case with subprime- inflation that could come from Obama's efforts to
backed CDOs. rebuild the economy, your best bet, if you are
seeking the safety of Treasurys, is Treasury
◆ Second, Shilling points out that they have Inflation Protected Securities (TIPS). These
gigantic liquidity, trading billions and billions securities are indexed with inflation so as prices
and billions each day. rise, so does the value of the principal and the
coupon payment.
◆ Third, in most cases Treasurys can't be called You can buys TIPS for 5, 10 and 20 years terms
before maturity as can many corporate and and the minimum investment was recently
municipal bonds. If interest rates decline, those dropped from $1,000 to just $100. The rate
bonds are called and you're forced to replace your adjusts every six months and the coupon rate
corporate or muni with a lower yielding bond. paid by TIPS adjusts according to changes in the
But if rates go up, they aren't called and you're consumer price index for urban consumers.
stuck with a lower-than-market-yielding bond. While TIPS are less volatile than Treasury
Heads the issuer wins, tails you lose. bonds and notes, their value and the coupon they
pay will fall are if prices decline. If inflation does
Shilling also says that with Treasurys you can be not occur, you have to be prepared to accept a
as aggressive as you want. There are no margin meager return.
requirements, so lenders will often lend 95% of Another worry: If instead of inflation, we actu-

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ally end up in a deflationary environment, the
value of the principal and the coupon will actual-
ly fall. For the three months ending in December,
the consumer price index has fallen 12.7%. The
good news here, is that even if prices do come
down significantly, there is a safety net. If you
hold the TIPS until maturity, you get back your
original principal—so that is safe. There is no
guarantee on the coupon rate.
Treasury Bills
Treasury bills are securities that have a length
of maturity that is less than one year (13, 26 or 52
weeks). Therefore, they are offered in a discount-
ed form. Instead of offering interest along with
the repayment amount, purchasers are offered
more money at the time of maturity than they
paid for the bill to begin with.
So if you were to buy a 3 month T-bill right
now for $10,000, you would have to pay
$9,996.46; a six-month bill sold for $9,983.82.
That would equal an annualized rate of 0.142%
for the three-month bills and 0.195% for the six-
month bills. But the yield here isn't great. Even
with the poor news coming out of the banking
sector and Microsoft's surprise announcement
that it would post an 11% drop in earnings for its
second quarter, the yield on the three-month T-
bill, considered one of the safest investments, rose
to 0.11%—practically zero.
Savings Bonds
Savings bonds differ from others in that they
are registered to one person only and therefore
cannot be actively traded. Also, they are the most
affordable kind of treasury investment, as
investors can purchase them for as low as $25.
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This is a low-risk savings product that earns
interest while protecting you from inflation. Right
now, it offers a relatively gigantic 5.64% annual
interest rate. Not an all-time high, but compared
to the alternatives, an appealing investment.
How to Buy Treasurys
You can buy Treasurys through various dis-
count and full service brokers. Bond brokers also
allow you to buy and sell treasurys. Savings Bonds
can be bought at just about any bank as well as
other financial institutions. Or you can go
through the "Treasury Direct" program, which
provides transactions for little or no fees.
Treasury Direct (www.treasurydirect.gov)
Tel: (304) 480-6144
One way to buy Treasurys is to go to Treasury
Direct, an electronic marketplace and online
account system where investors may hold and
conduct transactions in eligible book-entry
Treasury securities. The Treasury Direct system is
run by the Bureau of the Public Debt section of
the U.S. Treasury Department, a branch of the
federal government. Investors are able to partici-
pate in Treasury auctions and purchase debt secu-
rities, including U.S. savings bonds directly from
the U.S. Treasury. For buying government debt
securities, this program is relatively inexpensive
and trouble-free. Eligible securities include
Treasury bills, Treasury notes, Treasury bonds,
Treasury inflation-protected securities (TIPS).
Buying is simple. Once you log on, you can
click directly to purchase express, the online buy
order entry system. You'll be prompted to select
the owner of the security, as many investors buy
Treasuries for gifts and other charitable transfers.
You'll also select the product type or term, source
of funds and the amount of purchase. You can
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schedule the purchase for whenever you like and
how often you like, although dates are subject to
availability. The system will allow you to review
your order before submitting it. Savings bonds
are usually issued to your account within one
business day; T-bills, notes, bonds and TIPS are
issued within one week of the auction date.
The minimum purchase amount for savings
bonds is $25 per person per year in penny
increments up to $5,000. For T-bills, notes,
bonds, and TIPS, an investor may submit
noncompetitive bids from $100 up to $5 mil-
lion for each security type in $100 increments.
iShares Barclays TIPS Bond Fund (nyse: TIP) has an expense ratio of 0.20% a yields 6.46%.
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Bond Funds
You can also buy Treasurys and TIPS through
a bond fund to take advantage of the fund
manager's ability to stagger maturities and
trade for capital gains. Unless you own a fund
in a tax-deferred account, you'll have to pay
taxes on the inflation-based readjustment of
principal as well as on interest payouts. But
funds pay the adjustment of principal as
income, so you won't have to wait until the
bond matures to get it. Here are some bond
funds to consider:
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Vanguard Inflation-Protected Securities fund (VIPSX) has an expense ratio of 0.20% and yields 5.33%.

The SPDR Barclays Capital TIPS ETF (nyse: IPE) has an expense ratio of 0.19% and yields 5.97%.

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Vanguard Intermediate-Term Treasury (VFITX) has an expense ratio of 0.26% and a 30 day yield of
just under 2.5%. 85% of its assets are in regular Treasury debt or Treasury inflation-protected securities.

T.Rowe Price U.S.Treasury Intermediate (PRTIX) has an expense ratio of 0.54% and a 30 day yield of just
under 2.5%. 85% of its assets are in regular Treasury debt or Treasury inflation-protected securities.

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Vanguard Intermediate-Term Bond Index (VBIIX) has an expense ratio of 0.18% and a 30-day
yield of 4.72%. 54% of assets in government bonds—42% in Treasuries and 12% in agency securi-
ties—and the rest in investment-grade corporate bonds.

American Century Inflation Adjusted Bond (ACITX) has an expense ratio of 0.49% and yields 5.62%.

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Fidelity Inflation-Protected Bond (FINPX) has a 0.45% expense ratio and yields just under 2%.

Pimco Real Return (PRRIX) has a 0.45% expense ratio and yields 3.91%.

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