Sell or hold two TIPS bonds

[sailor234]

Probably this has been discussed but my searching has not found anything relevant. I have two TIPS bonds, both bought in 2008 when they got cheap, with maturities in January 2016 and January 2018. They have appreciated due to the drop in interest rates since 2008, but bond prices have been drifting down recently. We seem to be at the end of interest rate declines and rates may well be going up.

Here's a NY Times article on the current bond market: "Reading Pessimism in the Market for Bonds."
http://www.nytimes.com/2012/12/28/busin ... arket.html
"It is even possible that someone who bought a new Treasury security that will be issued on Monday will end up getting fewer dollars back than he or she invested — interest and principal combined — between now and when the bond matures in 2017. The securities are inflation-protected Treasury notes. If inflation ticks up significantly over the coming years, investors will get back more dollars than originally invested. But not enough to come close to keeping up with inflation. If there is no inflation, they will get back less than they invested."


The combined TIPS represent a small part of my overall debt portfolio. My question is whether I should sell the two TIPS and re-invest in other short term debt, CDs or treasuries, or just sit it out and, probably, watch the value decline. Or I could some of the proceeds for my RMDs coming up in 2013. Of course this could be called market timing, which I do avoid; is it different this time? All opinions are welcome to help me decide.

Thanks in advance.

Ray

[Rob5TCP]

I sold about 1/4 my TIPS a year ago (they were bought in 2008 as well)
I sold more than 1/4 this year. I have somewhere around 40% left and face the same
dilemma. If you sell them, what do you buy?

I will probably lower my % to somewhere between 25/30% of what I originally bought.
Are things different this time. I do not know.

I don't consider this market timing them because when I bought them, I was getting a real yield of 3+ per year.
I intended to hold them until they matured.

Now my real yields are negative.
I ask myself would I buy them now and my answer is no.
That is why I started selling them earlier this year.

When it is possible, I buy as much in I Bonds as I am allowed.
This has the best yield of the inflation adjusted bonds, unless you
go to nearly 20 years (and they were negative until recently).

[dbr]

A good question would be what was the plan when the allocation was placed in the first place?

[Aptenodytes]

The way I look at it is that the only compelling reason to hold individual bonds is in order to keep them until maturity, thereby eliminating the interest rate risk (and both the positive and negative potential that goes with interest rate risk). What you are proposing to do is to treat them more like speculative investments.

I understand the temptation -- I am sitting on a number of TIPS that have appreciated quite a bit. But I'm holding on to them because a) that was my original plan, and b) if I sold them I'd have to replace them either with something less valuable, or something that cost just as much anyway, or something that was more risky.

[Aptenodytes]

I sold about 1/4 my TIPS a year ago (they were bought in 2008 as well)
I sold more than 1/4 this year.
...

I don't consider this market timing them because when I bought them, I was getting a real yield of 3+ per year.
I intended to hold them until they matured.

Now my real yields are negative.

I don't quite get how real yields could change so much for an individual bond. The TIPS return is a function of the coupon yield, which is fixed, plus the inflation adjustment. If the inflation adjustment is equal to actual inflation, then the real yield is the coupon yield. The only way real yield could change over time, for a given TIPS bond, is for the difference between the inflation adjustment and the actual inflation to change over time. Is that what you are saying happened in your case?

I'm not a bond expert by any means, so apologies if I'm missing something obvious here.

[Rob5TCP]

I sold about 1/4 my TIPS a year ago (they were bought in 2008 as well)
I sold more than 1/4 this year.
...

I don't consider this market timing them because when I bought them, I was getting a real yield of 3+ per year.
I intended to hold them until they matured.

Now my real yields are negative.

I don't quite get how real yields could change so much for an individual bond. The TIPS return is a function of the coupon yield, which is fixed, plus the inflation adjustment. If the inflation adjustment is equal to actual inflation, then the real yield is the coupon yield. The only way real yield could change over time, for a given TIPS bond, is for the difference between the inflation adjustment and the actual inflation to change over time. Is that what you are saying happened in your case?

I'm not a bond expert by any means, so apologies if I'm missing something obvious here.

Because the price has gone up so much, the effective REAL (not nominal) yield is near zero or negative for the various
bonds I have. If inflation were zero between now and the maturity date, my bonds would have a near zero or negative
return (depending on the maturity).
Theoretically, with zero inflation I would receive LESS in both real and nominal terms (since with zero inflation they would be
the same) than what I can get now for them now.

[Aptenodytes]

Because the price has gone up so much, the effective REAL (not nominal) yield is near zero or negative for the various
bonds I have. If inflation were zero between now and the maturity date, my bonds would have a near zero or negative
return (depending on the maturity).
Theoretically, with zero inflation I would receive LESS in both real and nominal terms (since with zero inflation they would be
the same) than what I can get now for them now.

I understand now. I guess I wouldn't use the word "real" in this case, but rather something like "effective." "Real" I associate with return net of inflation, whereas in your case you are looking at return net of opportunity cost of holding on to the asset. As the price of the bond goes up, the opportunity cost goes up, lowering your effective return. That makes sense to me.

Perhaps I'm engaging in self-deception, but I just don't worry about that opportunity cost for my individual bonds -- as I said before that approach to mental accounting goes hand in hand with my decision to buy individual bonds in the first place. If I'm getting 3% return, net of inflation, based on my original purchase price, with no risk to principal, I'm happy. If someone taps me on the shoulder and says "If you want I'll buy that bond for 15% more than you paid for it" that doesn't reduce my happiness or the value of the 3% return.

[Rob5TCP]

Because the price has gone up so much, the effective REAL (not nominal) yield is near zero or negative for the various
bonds I have. If inflation were zero between now and the maturity date, my bonds would have a near zero or negative
return (depending on the maturity).
Theoretically, with zero inflation I would receive LESS in both real and nominal terms (since with zero inflation they would be
the same) than what I can get now for them now.

I understand now. I guess I wouldn't use the word "real" in this case, but rather something like "effective." "Real" I associate with return net of inflation, whereas in your case you are looking at return net of opportunity cost of holding on to the asset. As the price of the bond goes up, the opportunity cost goes up, lowering your effective return. That makes sense to me.

Perhaps I'm engaging in self-deception, but I just don't worry about that opportunity cost for my individual bonds -- as I said before that approach to mental accounting goes hand in hand with my decision to buy individual bonds in the first place. If I'm getting 3% return, net of inflation, based on my original purchase price, with no risk to principal, I'm happy. If someone taps me on the shoulder and says "If you want I'll buy that bond for 15% more than you paid for it" that doesn't reduce my happiness or the value of the 3% return.

I am using real to indicate yield after inflation. The real yield, again after inflation, is negative on these bonds. That is not what I bought my
TIPS for. All the tips I have ever bought (based on Larry Swedroe's book and Boglehead postings) is for TIPS yielding 2-3% above inflation.
Those real yields may never come back.
What I do know is these bonds were no longer doing what I originally purchases d them for (namely give me 3% above inflation).

[Aptenodytes]

I am using real to indicate yield after inflation. The real yield, again after inflation, is negative on these bonds. That is not what I bought my
TIPS for. All the tips I have ever bought (based on Larry Swedroe's book and Boglehead postings) is for TIPS yielding 2-3% above inflation.
Those real yields may never come back.
What I do know is these bonds were no longer doing what I originally purchases d them for (namely give me 3% above inflation).

I thought I understood before, but now I am confused again. If "inflation" refers to the CPI, then the real yield of the TIPS you bought in 2008 is the same today as it was in 2008.

[dbr]

If the objective of 3% real is no longer being met (ignoring the capital gains that allowed this investment to return handsomely as interest rates fell), then you will have to find an alternative that now yields 3% real. Once that is accomplished, it can be a reasonable question whether or not one should sell the TIPS and buy the other. Most likely there is no such alternative investment at this time that is also acceptable on grounds of comparable risk factors of various kinds. Most likely the outcome would be to hold the TIPS. An alternative is to sell the bonds and buy CD's for the time being. Another choice might be a stable value fund if you have one in your 401K and it is paying sufficiently (maybe 3% nominal if you are lucky) and you aren't risking too large a fraction of your assets (say less than 15%). If you believe in increasing risk when prospective returns are low, then you could sell the TIPS and buy stocks.

[Rob5TCP]

If the objective of 3% real is no longer being met (ignoring the capital gains that allowed this investment to return handsomely as interest rates fell), then you will have to find an alternative that now yields 3% real. Once that is accomplished, it can be a reasonable question whether or not one should sell the TIPS and buy the other. Most likely there is no such alternative investment at this time that is also acceptable on grounds of comparable risk factors of various kinds. Most likely the outcome would be to hold the TIPS. An alternative is to sell the bonds and buy CD's for the time being. Another choice might be a stable value fund if you have one in your 401K and it is paying sufficiently (maybe 3% nominal if you are lucky) and you aren't risking too large a fraction of your assets (say less than 15%). If you believe in increasing risk when prospective returns are low, then you could sell the TIPS and buy stocks.

When I sold, I bought some Ally CD's, which had a decent nominal yield (about 2%) and a 2 month penalty for cashing in.
A smaller percentage also went into equities.I did not have a stable value fund as an option. I also added some to my Vanguard REIT.

[DickBenson]

I thought I understood before, but now I am confused again. If "inflation" refers to the CPI, then the real yield of the TIPS you bought in 2008 is the same today as it was in 2008.

Let's take an extreme (and rough) example for illustration purposes.

Suppose you bought a $100 TIP bond with 2% real and there was 2% inflation. Then your return would be $4. The real return would be 2%.

However, if the market price of that bond has gone up to $200, you still would only receive a $4 return. This would be a return of only 2% on the value of your bond (now worth $200). Thus, although you received $4, the return would only be 2%, ... equivalent to the 2% inflation rate. The real return would be 0%.

Hope this is not adding to your confusion.

Dick

[Aptenodytes]

I thought I understood before, but now I am confused again. If "inflation" refers to the CPI, then the real yield of the TIPS you bought in 2008 is the same today as it was in 2008.

Let's take an extreme (and rough) example for illustration purposes.

Suppose you bought a $100 TIP bond with 2% real and there was 2% inflation. Then your return would be $4. The real return would be 2%.

However, if the market price of that bond has gone up to $200, you still would only receive a $4 return. This would be a return of only 2% on the value of your bond (now worth $200). Thus, although you received $4, the return would only be 2%, ... equivalent to the 2% inflation rate. The real return would be 0%.

Hope this is not adding to your confusion.

Dick

What you say is fully consistent and understandable.

[Call_Me_Op]

I have a couple of left-over bonds from 2008 as well - maturing in 2017. I plan to hang onto them. I don't think you'll make much money by selling them and reinvesting in other safe securities. If you want to take more risk - by all means sell them - but realize that you are taking more risk.

[nisiprius]

A good question would be what was the plan when the allocation was placed in the first place?

Indeed.

I keep an investment diary in which I make brief entries about every investment move I make, including the rationale and my future intentions. Since the diary is for my own use, and not to impress anyone, I try to be frank about the rationale (which is often bad). For example, the "rationale" for one move is listed as "fussing and flailing."

My entry for 1/8/2003 reads: "What to buy? I have enough stocks, bonds will probably tank when interest rates rise. All the long-term safe stuff is around the same rates, three or four percent. So, shrug, buy TIPS." And the future intentions are "hold to maturity," which happens to be my future intentions listed for every TIPS I've purchased.

I have a 1999 entry for QQQ for which the rationale was "Gambling money. Let’s have at least a small bet on the table for the great technology bonanza." And the "future intentions" entry was "Follow impulses."

I didn't buy TIPS during the 2009 dip. If I had bought them and said it was an opportunistic purchase and my plan was "follow impulses" I'd consult my right brain and follow my impulses. If I had said my plan was "hold to maturity," I would try to resist any impulse to sell. If I failed to resist and did sell them, at least Id know what my plan was, and my rationale for the sale will say something like "Decided not to follow my plan." I might screw up, but at least I will never have to say "WHAT was I THINKING?"

[larmewar]

You didn't post values for bonds or whether taxable vs. non-taxable. If the sales expenses aren't too great, you might consider selling up to your I-bond limits.

Lar