To TIP or not to TIP (funds)?

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talltodd
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To TIP or not to TIP (funds)?

Post by talltodd »

I'm holding the vanguard TIPS fund ( in tax advantages acct) and thinking of exchanging it for Total Bond Index. With the current Fed environment curious of people's thoughts? Thanks.
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kenyan
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Re: To TIP or not to TIP?

Post by kenyan »

There are basically four differences between Total Bond Market and Vanguard TIPS,

- TBM is an index fund. Vanguard TIPS is not, but basically acts just as one, for all intents and purposes other than Admiral Shares limits.

- TBM is a mix of corporates, treasuries, mortgage-backed securities. TIPS is just treasuries, and is therefore slightly higher quality overall.

- TBM is shorter duration and is therefore less sensitive to rate increases (but also benefits less from rate declines).

- TBM is nominal. TIPS is inflation-protected (duh).

The last bullet is the most important one, in my opinion. Inflation protection hedges against unexpected inflation. Low inflation doesn't matter, only unexpected inflation. Since this is the overriding difference, I think you should only change allocations if you think there is some reason that your need for protection against unexpected inflation has changed.
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Angst
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Re: To TIP or not to TIP?

Post by Angst »

I'm not sure what to make of this, but in replying to one of Nisi's posts in another thread, Vanguard's Intermediate TIPS fund was added to the following graphic showing how TIPS have fared worse than other bond funds since May 2013 when the "Taper Tantrum" dropped rates for a while. TIPS are yellow, TBM is blue, IT investment grade index is orange and IT corporate bonds index is green. If that's what's happened since 2013, should TIPS fund holders be a little more wary than TBM holders of the Fed's plans for eventually pushing rates up? I don't know, but I do wonder. Did something else happen in May 2013 that affected TIPS uniquely?

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livesoft
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Re: To TIP or not to TIP?

Post by livesoft »

This is a tough one because you would be selling low. OTOH, you are basically asking us if you should cut your losses and just go with TBM. Tough decision. I don't own TIPS. Would I sell here? Probably.
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Re: To TIP or not to TIP?

Post by #Cruncher »

talltodd in Subject line wrote:To TIP or not to TIP?
This subject title is confusing, Todd, since "TIP" is the ticker symbol for the iShares TIPS ETF and you are asking about a Vanguard TIPS fund.
talltodd wrote:I'm holding the vanguard TIPS fund ... and thinking of exchanging it for Total Bond Index. With the current Fed environment curious of people's thoughts? (underline added)
More confusion since you don't seem to realize there are two Vanguard TIPS funds: the Short-Term Inflation-Protected Securities Index Fund VTIPX and the broad-term Inflation-Protected Securities Fund VIPSX. With its 5.6 duration the Vanguard Total Bond Market Index Fund VBMFX is less sensitive to rising interest rates than the broad-term Vanguard TIPS fund with its 8.2 duration. But it is more sensitive than the short-term Vanguard TIPS fund with its duration of only 2.5.
Angst wrote:Did something else happen in May 2013 that affected TIPS uniquely
The share price of VIPSX fell 9.8% from $14.59 on 4/26/2013 to $13.16 two months later on 6/24/2013. This can be explained by the change in TIPS yields during the same period. For example, the yield on 7-year constant maturity TIPS rose 1.19% points. Applying the rule of thumb: 9.8% = 8.2% X 1.19.

Code: Select all

            5 YR    7 YR   10 YR   20 YR   30 YR
            ----    ----   -----   -----   -----
4/26/2013  (1.43)  (0.97)  (0.68)   0.01    0.42
6/24/2013  (0.14)   0.22    0.64    1.22    1.45
            ----    ----    ----    ----    ----
Change      1.29    1.19    1.32    1.21    1.03
During the same period the share price of VBMFX fell only 4.4% from $11.09 to $10.60. This can be pretty well explained by the change in nominal Treasury yields. For example, the yield on 5-year constant maturity nominal Treasuries rose 0.80% points. Applying the rule of thumb: 4.5% = 5.6% X 0.80.

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            5 YR    7 YR   10 YR   20 YR   30 YR
            ----    ----   -----   -----   -----
4/26/2013   0.68    1.10    1.70    2.47    2.87
6/24/2013   1.48    2.02    2.57    3.27    3.56
            ----    ----    ----    ----    ----
Change      0.80    0.92    0.87    0.80    0.69
VIPSX fell more than VBMFX for two reasons: 1) it has a longer duration and 2) TIPS rates rose more. The 2nd point seems logical if the market was expecting the Federal Reserve to tighten the money supply. This would decrease inflationary expectations and reduce the break-even increment of nominal Treasuries over TIPS.

Code: Select all

            5 YR    7 YR   10 YR   20 YR   30 YR
            ----    ----   -----   -----   -----
4/26/2013   2.11    2.07    2.38    2.46    2.45
6/24/2013   1.62    1.80    1.93    2.05    2.11
            ----    ----    ----    ----    ----
Change     (0.49)  (0.27)  (0.45)  (0.41)  (0.34)
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Re: To TIP or not to TIP?

Post by Angst »

#Cruncher wrote:VIPSX fell more than VBMFX for two reasons: 1) it has a longer duration and 2) TIPS rates rose more. The 2nd point seems logical if the market was expecting the Federal Reserve to tighten the money supply. This would decrease inflationary expectations and reduce the break-even increment of nominal Treasuries over TIPS.
Is it reasonable to think (conclude) that generally speaking, TIPS are less reliably assessed by means of duration than other bonds? I.e., they have unique component(s) of volatility that transcend(s) duration/interest rate sensitivity.

- US Govt. bonds might be most readily assessed (i.e. "accurately" assessed) by way of duration.
- Corporates/GNMA less so (negative convexity, e.g.)
- TIPS, even less so. The market might or might not be making inferences about what the Fed is trying to do with regards to "money supply" and so forth.
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Re: To TIP or not to TIP?

Post by abuss368 »

TIPS provide additional diversification to a portfolio. TIPS often act differently in markets than nominal bonds.

We presently invest in Total Bond Index in the tax advantaged accounts and Intermediate Term Tax Exempt in taxable. If I were to consider a second bond offering for diversification purposes, it would probably be the TIPS fund. I am still struggling with getting on board with the Total International Bond Index Fund regardless of Vanguard increasing the fixed income allocation recently.

From a tax perspective, TIPS are Treasury Bonds, and therefore exempt from State and Local Taxes.

Best.
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Re: To TIP or not to TIP?

Post by #Cruncher »

Angst wrote:Is it reasonable to think (conclude) that generally speaking, TIPS are less reliably assessed by means of duration than other bonds? I.e., they have unique component(s) of volatility that transcend(s) duration/interest rate sensitivity.
Duration measures a bond's price sensitivity to a change in yield. It works the same for TIPS as for any other bond that doesn't have a call provision.

I believe that TIPS are actually more easily assessed than other bonds because they remove one factor that affects the yields of other bonds: namely the future rise in consumer prices. Here is a chart from my post, Re: Are TIPs Poor Downside Protection?, that attempts to break down the factors affecting the yields of TIPS and nominal Treasuries:

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                   TIPS                 Nominal Treasury
                                     ----------------------  <-- 3.00%
                                     |     Unexpected     |
                                     |   Inflation Risk   |
                                     ----------------------  <-- 2.75%
                                     |                    |
                                     |      Expected      |
1.00% -->  ----------------------    |                    |
           |  Illiquidity Risk  |    |      Inflation     |
           |  vs Nominal Treas  |    |                    |
0.75% -->  ----------------------    ---------------------   <-- 0.75%
           |   Real Interest    |    |   Real Interest    |
0.00% -->  ----------------------    ----------------------  <-- 0.00%
This shows TIPS yields have only two components while nominal Treasury yields have three. The yields of other bonds (e.g., corporates, municipals, mortgage-backed) will have the three components of nominal Treasuries plus other factors such as credit risk and call risk that neither TIPS nor nominal Treasuries have.
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Re: To TIP or not to TIP?

Post by Aptenodytes »

It doesn't seem fair to ask us what we think and not tell us what you think.

What attracted you to TIPS? What made the attraction weaken?

I buy TIPS for a bit of inflation protection and haven't changed anything. I can't even make up a rationale for how Fed action could alter that. Some people think the world has become less vulnerable to inflation, but that isn't because of what the Fed is doing.
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Re: To TIP or not to TIP?

Post by abuss368 »

It appears that inflation is watched and monitored a lot these days. Could a 70's environment of high inflation happen again? I would expect anything is possible.
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Re: To TIP or not to TIP?

Post by elgob.bogle »

I purchase individual TIPS so that I have protection against unexpected inflation as well as unexpected deflation. TIPS purchased at auction can be redeemed at maturity for no less than the purchase price. There is an auction for 5-year TIPS in mid April. You will need a brokerage account at Vanguard if you are interested in letting them handle the transaction and hold the TIPS for you. Depending on the amount of $$ you have invested at Vanguard, there is no fee for the transaction. There is no ER.

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Re: To TIP or not to TIP?

Post by #Cruncher »

elgob.bogle wrote:TIPS purchased at auction can be redeemed at maturity for no less than the purchase price.
Not quite! From this TreasuryDirect PDF file:
At maturity, ... if deflation occurred over the life of the security and decreased the security’s value, Treasury pays the owner the original face value of the security. (underline added)
If the accepted yield at the upcoming auction is less than the 1/8% minimum coupon, the TIPS will sell at a premium. If the CPI declines over the 5 year life, you will not get back this premium. Neither will you get back the small increase in inflation-adjusted principal from the 4/15/2015 Dated date to the 4/30/2015 Issue date. According to Ref CPI for 2015:

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                04/15/15     04/30/15
               Dated Date   Issue Date
               ----------   ----------
Reference CPI   234.18067    234.68817
Index Ratio       1.00000      1.00217 = Ref CPI / Ref CPI on Dated date
For illustration, assume you buy $10,000 face value and the yield comes in at -0.5% -- approximately the yield of the outstanding 5-year TIPS maturing 4/15/2019 which was issued last year. (See WSJ TIPS Quotes 4/1/2015.) In this case the price would be about 103%. Your cost would then be

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10,322 =10000 * 1.00217 * 103%
If the Reference CPI is lower than 234.18067 at maturity on 4/15/2020, the Treasury will pay you only the $10,000 face value, not the $10,322 "purchase price". However, in my opinion, this is really just an academic exercise since the chance of the CPI falling over a five year period is quite remote.
elgob.bogle wrote:There is an auction for 5-year TIPS in mid April.
The auction is tentatively scheduled for 4/23/2015. (See Tentative Auction Schedule PDF File.) About a week before then the official announcement should be visible on the Upcoming Auctions web page.
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Re: To TIP or not to TIP?

Post by elgob.bogle »

Thanks for the education/explanation! I'm still going to place my order tomorrow!

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Re: To TIP or not to TIP?

Post by abuss368 »

Great thread.
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Re: To TIP or not to TIP?

Post by elgob.bogle »

Treasury Direct is now taking 5-yr TIPS orders. Indicative yield. exclusive of inflation, was -.482, factor 1.00217 at 11:30 am. It was -.481 at 11:50 am. "The Indicative Yield is an estimate based off the most recently issued Treasury security of similar maturity that is currently available among active platform participants. The actual treasury auction results will often vary from the Indicative Yield and you may receive at auction an actual yield that is higher or lower than the Indicative Yield. An Indicative Yield will not display for Treasury Floating Rate Notes (FRNs). "

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Re: To TIP or not to TIP?

Post by abuss368 »

I have not invested with Treasury Direct but instead preferred the simplicity of a mutual fund with Vanguard.
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Re: To TIP or not to TIP?

Post by gasdoc »

I used to have the Vanguard TIPS fund, but sold it a year ago. I finally got tired of waiting for inflation to happen. Maybe I'll regret it, but I went with Total Bond Index (.80) and International Bond Index (.20).
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Re: To TIP or not to TIP?

Post by abuss368 »

gasdoc wrote:I used to have the Vanguard TIPS fund, but sold it a year ago. I finally got tired of waiting for inflation to happen. Maybe I'll regret it, but I went with Total Bond Index (.80) and International Bond Index (.20).
Taxable or tax advantage accounts?

How is Total International Bond doing for your portfolio?

No cash flow from dividends for the TIPS fund?
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Re: To TIP or not to TIP (funds)?

Post by gasdoc »

abuss368 wrote:Taxable or tax advantage accounts?

How is Total International Bond doing for your portfolio?

No cash flow from dividends for the TIPS fund?
I only keep bonds in my tax advantaged (IRA AND ROTH IRA) accounts. Total International Bond Fund seems to move in a way that is unrelated to stocks, and a little different from US bonds. I have essentially a 4 bond portfolio- US stocks (taxable and tax advantaged), international stocks (taxable), US bonds (tax advantaged), and international bonds (tax advantaged). The four are all index funds. Then I have a couple of small actively managed stock funds from the past that I don't want to pay the taxes to exchange.
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Re: To TIP or not to TIP?

Post by tuckeverlasting »

livesoft wrote:This is a tough one because you would be selling low. OTOH, you are basically asking us if you should cut your losses and just go with TBM. Tough decision. I don't own TIPS. Would I sell here? Probably.
This was exactly my dilemma after investing in the VG Intermediate TIPS fund as a newbie, without really understanding what I was doing. The chart upthread shows what happened and after long anguishing I decided to cut my losses and sold at the end of last year. Glad I did.
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Re: To TIP or not to TIP (funds)?

Post by derosa »

Look at a current bond table for yields today. A 30 YEAR bond has a yield of 2.5%. A 10 YEAR note of 1.8%. So people are willing to tie their money up for 10 years for 1.8% or 30 years for 2.5%. Uhhh - no one is expecting any inflation. At least these are in positive territory. Go look at Europe for a real mess.

The best predictor of future yields and inflation is today's bond yields. No one is expecting any inflation.

And if there should be some event that triggers unexpected inflation? All funds will start buying them the same day. Buy your TIPS the next day along with everyone else.
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Re: To TIP or not to TIP (funds)?

Post by robert88 »

I think for intermediate term(5 year or less maturity) fixed income, FDIC insured CDs are the best deal. For longer maturities, I'm not sure why anyone would choose nominal treasuries over TIPS. The Fed's inflation target is 2%. If they hit that, the expected return on 30-year nominal treasuries is 0.51% real. The yield on 30-year TIPS is 0.53%. For taking on the risk of unexpected inflation with nominal bonds, the expected premium over TIPs seems to be almost zero.
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Re: To TIP or not to TIP?

Post by abuss368 »

tuckeverlasting wrote:
livesoft wrote:This is a tough one because you would be selling low. OTOH, you are basically asking us if you should cut your losses and just go with TBM. Tough decision. I don't own TIPS. Would I sell here? Probably.
This was exactly my dilemma after investing in the VG Intermediate TIPS fund as a newbie, without really understanding what I was doing. The chart upthread shows what happened and after long anguishing I decided to cut my losses and sold at the end of last year. Glad I did.
This was our situation as well. After a lon time, and upon watching a Jack Bogle interview where he mentioned to sell them, we sold the Intermediate TIPS fund. We invest in Total Bond and this has worked well.
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Re: To TIP or not to TIP (funds)?

Post by elgob.bogle »

Well - some folks are buying Individual TIPS. The prices of all TIPS in my intermediate ladder (10 yr) have been steadily increasing since about the time that the Euro Quantitative Easing started last month. The price of gold also has jumped a little. Do these price moves suggest unexpected inflation?

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