Healthy Financial Habits

In times when inflation is threatening the value of your dollar you want to hedge against its effects by putting your money in the right places.  One way of doing this is to add TIPS to your portfolio.

TIPS is an acronym for Treasury Inflation Protected Securities. TIPS are issued by the US Department of Treasury and pay interest twice a year. Owning them is virtually risk free since they are backed by the US government. They are sold in increments of $100 for either 5, 10, or 20 year periods and can be purchased directly through the US Treasury at www.treasurydirect.gov.  They can also be purchased through a bank or broker.

Here’s how they work:

The US treasury adjusts the principal amount that you invest up or down according to the CPI. The CPI is an inflation indicator that  is released monthly and shows a calculation of the average prices a household pays for goods and service compared to the previous month. The treasury also uses the CPI to calculate the amount to be paid as the maturity date is reached. As the CPI increases in an inflationary period your principal increases. The inverse is also true. As the CPI decrease your principal decreases. In a period of deflation where your principal falls below what you originally paid for your security you will receive your original principal.

These securities also pay bi-annual interest. The interest can be calculated by taking your adjusted principal (principal after CPI is factored in) and multiplying it by one half the interest rate as determined at the time of purchase.

For example on January 30, 2009 a 20 year TIPS yield was set at 2.5%.( the 20 year TIPS rate is set in January and July) If you were to put $2000 in 20 year TIPS with an interest rate of 2.5% and the CPI rises 3% your bi annual interest payment is calculated using the following equation:

$2,000 *1.03= $2,060

$2,060 * 2.5% / 2 = $25.00

Your 6 months would be $25.00.

Now the year is 2029 and your security is about to mature. Let assume that inflation rises  at a rate of 5% for the next 20 years. Using compound interest the payment at the maturity date would be $5.306.60

When buying TIPS please remember to keep them in a tax deferred IRA account because you are required to pay tax on both the principal and interest.  Additional information can be found at http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

Wouldn’t it be nice to have a place to park your cash at an annual interest rate of 5%-6% that is easily accessible without penalties for early withdraw? Well there is such a place and it’s as easy as establishing a free checking account. Well you might say “I’ve heard of high interest checking accounts such as the one that ING is offering with a whopping .025% APY but that’s an insult.” Well you are right! Large banks such as Wachovia, Bank of America, RBC, BB&T, etc are not offering a great yield on your cash. It is the smaller community banks and credit unions that want your money and offer a much greater return.

Earning 5%-6% does come with some minor drawbacks. But before I discuss the drawbacks let me point out the advantages of small banking.

Besides the obvious benefit of collecting a higher than average APY there are other advantages:

- Free checks. Some banking institutions offer free checks for signing up. Some even extend this offer indefinitely.

- No ATM fees. Many offer the advantage of not having to pay ATM transaction fees. Some community banks and credit unions realize that potential customers may shun smaller banks because they don’t saturate every block in every town like their competitors. By offering customers the ability to use any ATM with no fees this makes banking much easier.

-FDIC Insured. Most small banks are FDIC insured. Be sure to check with the FDIC website http://www2.fdic.gov/idasp/main_bankfind.asp and perform a search on the bank that you are interested in.

- Free postage paid envelopes. If you live in a remote area or an area that does not contain any banks that offer a high interest checking account you can mail in your deposits in free postage paid envelopes.

- Deposit money without leaving home. I would never suggest sending cash in the mail, however I would not hesitate to deposit checks through the mail. Just place the check(s) you would like to deposit in the provided  pre addressed, postage paid envelope and send it off.

- Better customer service experience. Having a high interest checking account at a smaller community bank or credit union gives you the opportunity to know your banker. You will usually deal with the same person and get to know each other.

-It’s fully accessible! This is one of the greatest advantages of having a high interest checking account. Most banks allow you to access all or most of your cash without penalty. Try that with a CD!

With the good come the bad. Here are a few disadvantages:

- Depositing cash can be difficult. Depositing checks are as simple as placing them in an envelope and mailing them. What about depositing cash? Well depositing cash is a bit more complicated. You have two options: Drive to the bank and make a deposit (can be difficult if your account is in a another city or even another state) or establish a local checking account, deposit the money there, write a check to yourself then mail it to your interest checking account.

- Meeting monthly requirements. Most high interest checking accounts require that you meet certain criteria each month such as completing 10 debit card transactions per month or setting up at least one direct deposit per month in order to receive the promised interest rate. This is not much of a disadvantage if you use this as your primary checking account.

- Limits on amount that you can earn interest on. Some banks place limits on the amount that you can collect interest on. Limitations range from $25,000 to $100,000 depending on what state you choose. Remember, the primary reason for using an interest checking account is to have accessible cash for emergency situations, vacation,  saving for a down payment on a house, etc. This would not be a wise long term investment decision.  There are other investment options that produce greater yields but require that you lock your cash in for long periods of time.

- Depositing through the mail can take time. By making deposits via snail mail you have to wait for the post office to deliver your deposit to your bank and wait for them to process it. This can take anywhere from 3 to 10 days from the time it leaves your mailbox- a definite disadvantage when time is money.

- Receive electronic statement in lieu of paper. Chances are that if you are reading this article on the internet you would have no problem receiving an electronic statement. Some old timers may become frantic at the thought of an e-statement. I’m not exactly sure why but maybe they believe that the bank absconded with their money if they don’t receive that piece of paper in the mail every month?

Check out http://www.highyieldcheckingdeals.com/ for a fairly comprehensive listing of high yield checking accounts that may be available your. Remember, if you don’t reside near one of these banks don’t get discouraged. It may be a little more work to send your deposits in but its well worth the effort. Also, some of these accounts are offered nation wide which increases the likelihood of you finding the one that best fits your needs.

Ultimately it is up to you to weigh out the pros and cons to establishing a high interest checking account. It is my opinion that the pros outweigh the cons by far.