FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client, aged 68, is concerned about inflation eroding the purchasing power of their retirement savings. They are looking for an investment that provides income and potential for capital appreciation while protecting against inflation. Which of the following securities would be MOST suitable for this client's objective?
- ATreasury Inflation-Protected Securities (TIPS)
- BHigh-yield municipal bonds
- CTreasury Bills (T-Bills)
- DLong-term corporate bonds
Show answer & explanationAnswer & explanation
Correct answer: A. Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities (TIPS) are specifically designed to protect investors from inflation. Their principal value adjusts semi-annually based on changes in the Consumer Price Index (CPI), and the interest payments are then calculated on this adjusted principal, providing both income and inflation protection.
Why the other options are wrong
- B. High-yield municipal bonds offer tax-exempt income but carry significant credit risk and do not provide inflation protection.
- C. T-Bills are short-term, low-yield instruments that offer no inflation protection and minimal capital appreciation.
- D. Long-term corporate bonds offer income but are highly susceptible to interest rate risk and do not protect against inflation.
Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds designed to protect investors from inflation. Their principal value adjusts with the Consumer Price Index (CPI), and the interest rate is applied to the adjusted principal, ensuring purchasing power is maintained.
- Principal adjusts semi-annually with CPI.
- Fixed coupon rate applied to adjusted principal.
- Issued by U.S. Treasury, virtually no credit risk.
- Interest and principal adjustments are federally taxable in the year earned (phantom income).
Memory trick: TIPS Protect against Inflation's Bite.