TIPS or VIPSX and why?

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BeaverFood
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TIPS or VIPSX and why?

Post by BeaverFood »

I've read through some of the theoretical discussions on TIPS versus TIPS funds but I think I'm getting lost on the theoretical nature of the discussion and confusing myself even more!

We're both 35 so have approximately 30 years until retirement give or take depending on finances. Looking to expand taxable retirement investment within the next year. We're currently short on inflation protected investments and need to increase that in our taxable portfolio to achieve our desired AA. We do not anticipate selling prior to retirement and can hold into retirement as needed.

So, in this scenario--would you buy individual TIPS or more shares of VIPSX in a taxable account? Why?
dbr
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Re: TIPS or VIPSX and why?

Post by dbr »

I would probably be accumulating I bonds over the thirty years to retirement. The first of them would be ready to redeem as soon as you retire.

If it is TIPS, I choose funds for the simplicity and convenience.

I am not sure with thirty years to retirement that I would be buying TIPS at all, however.

The exception might be that you have decided on a TIPS ladder scheme for retirement financing, meaning that it is time to start building a ladder of thirty year bonds. That probably isn't how I would have done things even if I had been aware of the possibility at your age.

There is also the fact that people who had the chance to load up on long TIPS when real rates were high made a good decision in hind sight. That opportunity is not what exists today. It would be an example of what Larry Swedroe says about inflation indexing opening the opportunity to go longer in bonds.

Conclusion: There is not a cut and dried answer to your question. Maybe it doesn't matter.
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Phineas J. Whoopee
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Re: TIPS or VIPSX and why?

Post by Phineas J. Whoopee »

BeaverFood wrote:...
So, in this scenario--would you buy individual TIPS or more shares of VIPSX in a taxable account? Why?
I agree with what dbr wrote, and would like to add a not why because it usually comes up in these sorts of discussions.

TIPS are adjusted for inflation, which is usually upward. The inflation adjustment is taxable in the year it happens, and because you're talking about a taxable account it's relevant. With individual TIPS the principal is simply adjusted, with no cash involved. Sometimes people complain that's a "phantom gain", in their words, which is no good because it didn't pay cash to pay taxes with. They have their point.

A TIPS fund pays out the inflation adjustments, when positive, as a cash dividend. The "phantom gain" camp often say that's better, because now you have cash flow to pay taxes with in the current year. The problem is inflation compounds. If the full inflation adjustment isn't reinvested into the TIPS fund, the value of your investment will fail to compound as quickly, and your purchasing power will fall behind.

If you're looking at a taxable account, it really makes no difference whether the principal is adjusted or the adjustment is paid out in cash, because every dollar is just the same as every other dollar. If your purpose with the TIPS is to keep up with inflation over three decades and more the adjustments need to be reinvested, either implicitly or explicitly.

The phantom income issue does not matter in terms of whether you hold TIPS directly or a TIPS fund, so long as you can raise the cash to pay each year's income tax.

That said, I tend to agree that the case for you including TIPS is weak, given what you've told us. They probably do provide a diversification benefit when held with nominal bonds, but they've not been around long enough for us to say what that is, reliably.

To sum up, don't buy a fund rather than individual TIPS just to get inflation adjustments in cash so you can draw from them. There may be other reasons, but that isn't one.

And anyway, if the two of you buy I Bonds at Treasury Direct, and deliberately overpay income tax before filing (which you can do at the last minute so it isn't as if you have to give a zero-interest loan during the year), under present rules you can acquire up to $25,000 worth annually. That may be enough to get you any inflation protection you'd want without dealing with current taxes (all savings bond interest is inherently tax-deferred, if you want it to be, for as long as 30 years).

PJW
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#Cruncher
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Re: TIPS or VIPSX and why?

Post by #Cruncher »

BeaverFood wrote:... would you buy individual TIPS or more shares of VIPSX in a taxable account? Why?
In a taxable account I'd buy a TIPS fund [1] rather than individual TIPS to simplify the tax accounting. In my post, Re: TIPS: individual vs fund?, I list five items that can complicate taxes with individual TIPS but not with a TIPS fund. However, I concur with dbr & PJW that you should buy I Bonds first. [2] Only after reaching the limit would I invest in TIPS -- either individually or via a fund..
  1. I'd consider the Schwab U.S. TIPS ETF™ SCHP instead of VIPSX because of the lower expense ratio (0.07% vs 0.20%) and because it is a true index fund. Also, if you want to reduce duration in the current low interest rate environment, consider investing in a shorter term TIPS fund than SCHP or VIPSX. I list five such funds in the footnote to this post.
  2. But I disagree with dbr's comment, The first of them would be ready to redeem as soon as you retire. Given today's low fixed rate on I Bonds, it's likely you'll redeem them and put the proceeds into a higher yielding fixed income alternative well before you retire in 30 years. This is a benefit of I Bonds. When interest rates rise you can redeem them without incurring a loss as would happen with TIPS.
Edit 10/11/14 7:35 AM CDT: added the following:
dbr wrote:I am not sure with thirty years to retirement that I would be buying TIPS at all, however.
Phineas J. Whoopee wrote:... I tend to agree that the case for you including TIPS is weak, ...
I don't understand why many on this forum seem to think that holding TIPS (individual or in a fund) in one's portfolio requires some special justification. I never see it argued that holding nominal Treasury bonds requires a similar justification. Except for certain "free lunches" (e.g., CDs and I Bonds) and trading off higher risk for expected higher after-tax return (e.g., municipals and corporates), I'd put all my fixed income into TIPS and none into nominal Treasuries. TIPS have every advantage of nominal Treasuries plus they offer protection against unexpected inflation. And now the "price" for that protection is cheap in my opinion. Here is the current breakeven inflation rate (from Constant Maturity Yield Curve, nominal Treasuries and TIPS).

Code: Select all

Date       5 yr    7 yr   10 yr   20 yr   30 yr
--------   ----    ----   -----   -----   -----
10/10/14   1.55    1.99    2.31    2.77    3.03  nominal Treasuries
10/10/14   0.03    0.29    0.35    0.71    0.93  TIPS
           ----    ----    ----    ----    ----
           1.52    1.70    1.96    2.06    2.10  break even inflation rate
The red line in the graph in this post shows that the 10-year breakeven is at its lowest in a year.
Last edited by #Cruncher on Sat Oct 11, 2014 7:36 am, edited 1 time in total.
FinancialDave
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Re: TIPS or VIPSX and why?

Post by FinancialDave »

I am not sure with thirty years to retirement that I would be buying TIPS at all, however.
+1

I agree - over the next 30 years I'll invest in VTSAX (TSM) and you invest in TIPS -- is there anyone here who thinks TIPS will give a better "real" return above inflation.

Sure TIPS can diversify a portion of your bond portfolio, but let's just not claim they are going to be better over 30 years than equities.

fd
I love simulated data. It turns the impossible into the possible!
Topic Author
BeaverFood
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Joined: Fri Jul 26, 2013 1:29 pm

Re: TIPS or VIPSX and why?

Post by BeaverFood »

Thank you all so much for the help and insights!

As a follow up, I'm now trying to work up the asset allocation between our various accounts for our bond portfolio. We currently have the following:
Within 401k/401As:
Blackrock U.S. Bond Index Fund (WFBIX, ER 0.12%)
Vanguard Total Bond Market Index Fund (VBMPX, ER 0.05%)

In a tIRA:
Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX, ER 0.20%)

We plan to add I Bonds and a state muni bond fund (ER .73%) over the coming year and those will be held outside our tax advantaged space.

So, what is an ideal asset allocation between these options? Is 1/2 nominal bonds and 1/2 inflation protected ideal? How much should we aim for with the state muni fund?

(Yes, I now appreciate how good the investment options are between our 401k/401a accounts!)
mjb
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Re: TIPS or VIPSX and why?

Post by mjb »

dbr wrote:I would probably be accumulating I bonds over the thirty years to retirement. The first of them would be ready to redeem as soon as you retire.

If it is TIPS, I choose funds for the simplicity and convenience.

I am not sure with thirty years to retirement that I would be buying TIPS at all, however.

The exception might be that you have decided on a TIPS ladder scheme for retirement financing, meaning that it is time to start building a ladder of thirty year bonds. That probably isn't how I would have done things even if I had been aware of the possibility at your age.

There is also the fact that people who had the chance to load up on long TIPS when real rates were high made a good decision in hind sight. That opportunity is not what exists today. It would be an example of what Larry Swedroe says about inflation indexing opening the opportunity to go longer in bonds.

Conclusion: There is not a cut and dried answer to your question. Maybe it doesn't matter.
I agree that the OP should consider I-bonds due to their tax efficiency and the 30 year timeframe of I-bonds.
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Phineas J. Whoopee
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Re: TIPS or VIPSX and why?

Post by Phineas J. Whoopee »

#Cruncher wrote:...
Edit 10/11/14 7:35 AM CDT: added the following:
dbr wrote:I am not sure with thirty years to retirement that I would be buying TIPS at all, however.
Phineas J. Whoopee wrote:... I tend to agree that the case for you including TIPS is weak, ...
I don't understand why many on this forum seem to think that holding TIPS (individual or in a fund) in one's portfolio requires some special justification. I never see it argued that holding nominal Treasury bonds requires a similar justification.
...
I understand your reasoning, #Cruncher, and I agree. It's especially humbling because I've obliquely made the same argument in earlier threads. :oops:

Thanks as always for keeping me honest. :thumbsup

PJW
JD
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Re: TIPS or VIPSX and why?

Post by JD »

BeaverFood wrote:We plan to add I Bonds and a state muni bond fund (ER .73%) over the coming year and those will be held outside our tax advantaged space.
That ER of 0.73% is too high for any state muni, imo.
dbr
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Re: TIPS or VIPSX and why?

Post by dbr »

Phineas J. Whoopee wrote:
#Cruncher wrote:...
Edit 10/11/14 7:35 AM CDT: added the following:
dbr wrote:I am not sure with thirty years to retirement that I would be buying TIPS at all, however.
Phineas J. Whoopee wrote:... I tend to agree that the case for you including TIPS is weak, ...
I don't understand why many on this forum seem to think that holding TIPS (individual or in a fund) in one's portfolio requires some special justification. I never see it argued that holding nominal Treasury bonds requires a similar justification.
...
I understand your reasoning, #Cruncher, and I agree. It's especially humbling because I've obliquely made the same argument in earlier threads. :oops:

Thanks as always for keeping me honest. :thumbsup

PJW
Yes, I also agree there is no reason to be "against TIPS." However, the original quote was not meant to be a dictum. Part of the conversation was a suggestion to consider I bonds because the timing and circumstances might make that a good suggestion. Also, the conclusion was that it would not matter, for or against TIPS, as you say. Keeping investing more simple can be an idea.

However, thank you for a good comment.
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