by Archie M. Richards, Jr.
September 18, 2006

Ray asks, "Should I replace my long-term Treasury bonds with Treasury Inflation-Protected Securities (TIPS)?"

No, stay with the long-term bonds, Ray.

TIPS are Treasury bonds that provide protection against inflation. If the general price level goes up by 2 percent, for example, both the interest payments and the payoff at maturity are increased by 2 percent. These increases would offset the dollar's declining buying power.

TIPS are popular these days, along with gold and energy investments. It's an inflation bandwagon. Stay off it. On economic matters, the majority is usually wrong. The rate of inflation is not going to increase from here, certainly not much.

High inflation is caused by bad economic policies and high tax rates. During the 1970s, for example, we had top tax rates of 70 percent on income and capital gains. With government taking this much of rich people's income, they didn't have enough left to provide the buildings and machinery that support the work of employees. Productivity remained low, and unemployment soared.

Also in the 1970s, price controls and heavy regulation of transportation and telephones interfered with the smooth working of the economy. At the same time, the Federal Reserve Bank created a flood of new money to prevent a depression. The eventual result was very high inflation with long-term interest rates well above 10 percent.

Economic policies are far from perfect today. But they're a great deal better than they were 40 years ago. Top income tax rates have dropped by half from 70 percent to 35 percent. Taxes on capital gains and dividends have plummeted from 70 percent to only 15 percent. Regulations are still onerous, but the government no longer sets prices for most of the economy. All of those policies were disastrous.

The result of the current improvements is a highly productive economy. Oh, we're in the middle of a temporary spurt of inflation - a delayed reaction to the rapid money growth to prevent the 2001 recession from worsening. But this won't last.

Besides, new technologies are coming that will unleash a flood of goods and services. These will outstrip the growth of money and cause inflation to decline to zero. Prices may even fall.

As a result, TIPS will lose value. But as interest rates go down, the prices of long-term Treasuries will rise. Keep them. But be sure to add stocks to the mix.

Bill writes, "I have heard of a plan where I can sell my home to my children and pay them rent for me to live there. This would get the house out of my estate in case I end up in a nursing home. The house is paid for. Any suggestions?"

Talk with an elder-law attorney, Bill, about that nursing home business. The government has made it more difficult to qualify for Medicaid by running down your estate.

Concerning just the house, I see two good possibilities:

• If you have no special need for cash, you might give the house to your children with a retained life estate. This means you continue living in the house for as long as you please. When you move or die, the retained life estate expires and house is owned completely by the children. This takes it out of your taxable estate.

• If you do need cash, consider turning your house into money with a reverse mortgage. You can receive 1) cash up front, 2) regular income for the rest of your life, or 3) a combination of the two. The choice is yours, and you can use the money for any purpose. When you move or die, the house is sold and the loan repaid. If the proceeds of the house are less than the loan balance, the bank eats the loss. If the proceeds of the house are greater than the loan balance, your estate or the estate's beneficiaries receive a check for the difference.

Either of these two alternatives seems better than paying your children rent.