Key Takeaways
- Zero-coupon bonds from separated Treasury payments.
- Sold at deep discount, pay face value at maturity.
- No reinvestment risk; backed by U.S. government.
- Sensitive to interest rate changes; price volatility high.
What is Treasury STRIPS?
Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities) are zero-coupon securities created by separating the principal and interest payments of U.S. Treasury notes, bonds, or TIPS. These instruments sell at a significant discount and pay a single amount at maturity equivalent to the face value.
Investors acquire STRIPS through brokers or dealers rather than directly from the U.S. Treasury, making them accessible for those seeking predictable, long-term returns.
Key Characteristics
Treasury STRIPS offer unique features ideal for certain investment goals:
- Zero-coupon nature: No periodic interest payments; returns come solely from price appreciation to face value at maturity.
- Separate components: Principal and each coupon payment are detached and traded individually with distinct CUSIP identifiers.
- Range of maturities: Available from short-term to over 30 years, aligning with various financial plans.
- Tax treatment: Subject to federal income tax on imputed interest annually, even without cash received.
- Credit safety: Backed by the U.S. government, making them a reliable safe haven investment.
How It Works
Treasury STRIPS are created by "coupon stripping," where the principal and each semi-annual interest payment of a Treasury note or bond are separated and sold as individual zero-coupon securities. You purchase these at a discount, and the return equals the difference between the purchase price and the amount paid at maturity.
The lack of periodic coupons eliminates reinvestment risk, and maturities can match your financial timeline. Brokers can also recombine STRIPS to recreate the original Treasury security if desired. Managing the Macaulay duration of your portfolio can help control interest rate sensitivity when investing in STRIPS.
Examples and Use Cases
Treasury STRIPS suit investors targeting specific future cash needs or seeking to minimize reinvestment risk:
- Retirement planning: Aligning STRIPS maturity with retirement dates ensures a lump sum when needed.
- Education funding: STRIPS can provide guaranteed funds for college tuition, often held in tax-advantaged 529 plans.
- Corporate treasuries: Companies like Delta may use STRIPS or related bond investments to match liabilities.
- Diversification: Investors can access STRIPS exposure via bond ETFs; check out the best bond ETFs for options that include zero-coupon Treasuries.
Important Considerations
While Treasury STRIPS offer safety and predictability, their long durations make them highly sensitive to interest rate changes, resulting in price volatility. You should consider holding STRIPS in tax-deferred accounts to mitigate the impact of annual taxes on imputed interest.
Before investing, explore the services of best online brokers to find platforms that facilitate STRIPS trading efficiently and with low costs. Understanding your portfolio’s obligation structure will also help you use STRIPS effectively in your broader fixed-income strategy.
Final Words
Treasury STRIPS offer a predictable, zero-coupon investment with no reinvestment risk, making them suitable for long-term goals. To evaluate if STRIPS fit your portfolio, compare current yields and maturities through your broker to find the best match for your financial timeline.
Frequently Asked Questions
Treasury STRIPS are zero-coupon bonds created by separating the principal and interest payments from U.S. Treasury notes, bonds, or TIPS. They are sold at a deep discount and pay a single lump sum at maturity.
STRIPS work by detaching the principal and each semi-annual interest payment from eligible Treasury securities into individual zero-coupon securities. Investors buy them at a discount and receive the full face value at maturity, with no periodic interest payments.
No, Treasury STRIPS cannot be purchased directly from the U.S. Treasury. Investors must buy them through brokers, dealers, or financial institutions, usually with a minimum investment of $100.
STRIPS are backed by the U.S. government, eliminating default risk, and they carry no reinvestment risk since they pay only once at maturity. They are also exempt from state taxes and work well in tax-deferred accounts like IRAs or 529 plans.
The main risk is interest rate risk, as STRIPS, especially those with long maturities, can experience sharp price declines if interest rates rise. Additionally, investors must pay federal taxes annually on the imputed interest even though no cash is received until maturity.
To invest, open a brokerage account with firms that handle government securities, select STRIPS based on maturity and yield, place an order at the market price (minimum $100), and decide whether to hold to maturity or sell earlier on secondary markets.
Yes, brokers can recombine the separated principal and interest components of STRIPS to reassemble the original Treasury bond if desired.
Yes, investors can access STRIPS through ETFs or mutual funds that hold these securities. This approach can offer easier diversification and reduce sensitivity to changes in interest rates.
