A Breakdown of Treasury STRIPS

Treasury separate trading of registered interest and principal securities (STRIPS) are bonds with absolutely no interest rate. This means the bonds pay nothing to the investors while they are active. Instead, the only measurable profit on the bonds occurs through accretion. The Treasury pays out the bond at par value once it matures. The investor has very little taxable income while the bond is active, a set guaranteed profit and very little risk. However, a Treasury STRIP offers a fairly low profit compared to other investments. 

Accretion Value

When a STRIPS bond is sold, a "par value" is quoted, and then the bond is sold below that par value. When the bond matures, the Treasury pays the investor back the exact par value that was quoted at the beginning of the contract. The difference between this sales price and the initial price is the accretion amount. This represents your total profit on the investment. As a result, you will know exactly how much you will earn off the bond from day one. The par value never changes, despite the effect of inflation or any other factor. 

Lack of Interest

One challenge with a STRIPS bond is there is absolutely no payment at all while you hold the bond. Most Treasury bonds pay an interest rate on a quarterly basis. With a STRIPS bond, you make no income, and this limits the potential use of the bond. STRIPS bonds are best when you are looking for a very low-risk investment designed to increase your capital assets. If you need income for day-to-day expenses, STRIPS bonds are not valuable for your portfolio. For example, investing in STRIPS bonds in order to save for retirement is wise. Investing in the bonds once you are retired will provide you with no immediate benefit to help supplement your income.

Tax Benefits

The tax benefits of a STRIPS bond are simple. Since there is no real income on an annual basis, you are not taxed on the investment income. There may be a small tax based on the accretion value during the given year. However, if the bonds are held in a retirement account or tax deferred account, no tax may be assessed. If you are looking for an investment that is very easy to manage, then, a STRIPS bond may be a good option. On the whole, you can ignore the bond while it is still active. You will have very low tax requirements from the bond each year.

Risk Level

STRIPS bonds are not highly risky. The main risk with this type of investment is the threat of high levels of inflation knocking down the profit you earn on the bond purchase. For example, if the accretion value on your bond is 6 percent, you will profit more if inflation is 1 percent than if inflation is 3 percent over the lifetime of the bond. STRIPS bonds are not inflation-protected. As a result, if a period of high inflation does occur, you may actually lose money on the bond investment because inflation outpaced the accretion rate.