TIPS FROM UNCLE SAM

By Adam Zagorin/Washington

Hey, want a hot investment tip? Better make that TIPS, the acronym for a new class of U.S. government bond that went on sale last week--and quickly turned into the Treasury Department's version of Tickle-Me Elmo. The new wonder bonds, known as Treasury Inflation Protection Securities, were snapped up by institutional investors such as insurance companies and pension funds, which lugged $37 billion to the table, even though only $7 billion worth of the 10-year notes were actually up for sale.

TIPS promise a twofold benefit: first, to safeguard investors' principal against the ravages of rising prices; second, to cut the cost of financing America's $4 trillion national debt. Wall Street too is happy: bond dealers get a new plaything in the bargain. Gushes Deputy Treasury Secretary Larry Summers: "This is a win-win idea: better for citizens, better for government, better for financial markets."

Conservative investors favor Treasury securities for safety--they are backed by the full faith and credit of the U.S. government--but during inflationary periods their value automatically erodes. Not TIPS: the note's principal is adjusted daily to keep up with increases in the Consumer Price Index, and payments are made twice a year based on that adjusted value. Thus if inflation remains at its current level of roughly 3% over the next two years, the principal value of a $100,000 TIPS would rise to $103,000 by the end of 1997, and the annual interest payment would amount to $3,552. The note would rise to more than $106,000 in value at the end of 1998 and pay about $3,655 in interest. The trade-off is a lower coupon: last week's paper carried an initial interest rate of 3.45%, compared with 6.6% for a similar non-inflation-adjusted Treasury note.

Yet TIPS may not be the ticket for everyone. Not only is the interest income taxable, but so are the biannual adjustments to principal. That's why, at least initially, the bonds may work best for tax-deferred accounts like IRAS and 401(k)s that can be set up through brokers and employers.

While TIPS are less risky, they are also less rewarding. For example, S&P 500 stocks have returned a real average of 11.2% annually over the past 10 years, compared with an expected 3.5% or so return from the new Treasury note. Thus buyers will have to decide for themselves the level of risk, inflation protection and tax bite they are willing to accept.

TIPS definitely make sense for the government. The new issues could eventually lower the Treasury's cost of borrowing by billions. No wonder plans call for a second auction in April that might offer TIPS in a variety of maturities so you can ward off inflation for as many years as you like.

--By Adam Zagorin/Washington, with reporting by Bruce van Voorst

With reporting by BRUCE VAN VOORST