TIPS & Rick Ferri

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tomd37
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TIPS & Rick Ferri

Post by tomd37 »

I own and have read all of Rick Ferri's books. I am wondering if anyone knows if Rick has made any changes in the TIPS portion of his asset allocation recommendations since short-term TIPS have come onto the market. He always used the regular TIPS fund in his portfolio examples, but I am wondering if that might have changed in the past year or two with the introduction of the short-term TIPS fund. Maybe he will be reading this and will respond personally or maybe others have personal knowledge of his more recent recommendations.
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Re: TIPS & Rick Ferri

Post by Rick Ferri »

Hi, Tom.

Thanks for asking. I haven't made changes to the portfolio for long-term investors. There are uses for the short-term TIPS fund, though. Here are a couple of recent articles I wrote about TIPS:

The Purpose Of TIPS In A Portfolio

Tips on TIPS

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Re: TIPS & Rick Ferri

Post by larryswedroe »

fwiw
The BIGGEST advantage of TIPS IMO is that they allow you to earn the term premium without taking inflation risk
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Re: TIPS & Rick Ferri

Post by alwayshedge »

My 401k includes this TIPS fund in its offering: Vanguard Inflation-Protected Secs Adm

Im currently running the 3 fund portfolio in my 401k with Vanguard Total Bond for the bond portion. Would it be wise for my to adjust the bond allocation to include this Vanguard TIPS fund?
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Re: TIPS & Rick Ferri

Post by tomd37 »

Thanks to both Rick and Larry for their response. Your contributions to this forum are appreciated by the readers. :beer
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Re: TIPS & Rick Ferri

Post by elgob.bogle »

"Would it be wise for my to adjust the bond allocation to include this Vanguard TIPS fund?" Some of us do. I don't like the Mortgage Backed Securities in the Total Bond Fund. One can break it down to its component parts and substitute for MBS and/or any of its other components. You could do that with TIPS, Treasuries and Corporate bonds. Some don't like the duration of Total Bond Market, so they substitute the short term versions of the component funds. Best for you to do your homework before you decide.

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Last edited by elgob.bogle on Sun Sep 28, 2014 1:46 pm, edited 1 time in total.
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Re: TIPS & Rick Ferri

Post by Rick Ferri »

larryswedroe wrote:fwiw
The BIGGEST advantage of TIPS IMO is that they allow you to earn the term premium without taking inflation risk
Larry
Good point. On the flip-side,TIPS add deflation risk. Prices fall causing the par value of TIPS to fall, although they will never mature below their original issue price.

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Re: TIPS & Rick Ferri

Post by #Cruncher »

tomd37 in original post wrote:... since short-term TIPS have come onto the market.
[ Picky warning :wink: ] Most of us here --myself included -- think Vanguard is terrific and use it for much of our investments. However, I still find it rather confusing (and definitely provincial!) when a post simply says "short-term TIPS" when it really means "Vanguard short-term TIPS fund". There are several other short-term TIPS funds, two of which began before the Vanguard one. * And of course short-term TIPS existed before there were any funds that invested in them.
Rick Ferri in [url=http://www.bogleheads.org/forum/viewtopic.php?p=2206700#p2206700]this post[/url] wrote:... [ TIPS ] will never mature below their original issue price.
This isn't necessarily so. For example, the 5-year TIPS maturing 4/15/2018 was originally issued 4/30/2013 at an inflation-adjusted price of 107.82071%. (See auction results PDF file.) At maturity the Treasury will redeem for its inflation-adjusted value at that time -- but in no event for less than 100%. Therefore, if the CPI rises less than 7.82% over the 5 years, the purchaser will receive less than he paid. I think what Rick means, is that a TIPS won't be redeemed for less than its original principal value, not its original price.

* Here are some short-term TIPS funds and their annual fees listed in order of inception:
08/20/2009 - 0.20% - PIMCO 1-5 Year U.S. TIPS - STPZ
12/01/2010 - 0.20% - iShares 0-5 Year TIPS Bond ETF - STIP (0.20% fee reduced to 0.10% through Feb 2016)
10/12/2012 - 0.10% - Vanguard Short-Term TIPS ETF - VTIP
05/29/2013 - 0.15% - SPDR® Barclays 1-10 Year TIPS ETF - TIPX
02/26/2014 - 0.15% - SPDR® Barclays 0-5 Year TIPS ETF - SIPE
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Re: TIPS & Rick Ferri

Post by CWRadio »

What causes the NAV of a TIP fund to increase? I am still confused on how TIP funds work. Paul
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Re: TIPS & Rick Ferri

Post by Rick Ferri »

At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. Original principal is it's price ratio to par value at issuance (quoted as a price; 102.3, 100.8, etc). This provision protects you against deflation if you buy a bond at issuance.

TIPS increase is par value with inflation. If inflation is up 20% over the life of a TIPS, then the par value also goes up 20%, which means the dollar amount paid at maturity is 20% higher than par at issuance, and interest is up 20% (just the dollar amount, not the coupon rate).

TIPS are a confusing topic because there's lots of moving parts.

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Re: TIPS & Rick Ferri

Post by hoops777 »

If one has 20000 a year to invest in tips or ibonds for a husband and wife which is the better choice?
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Re: TIPS & Rick Ferri

Post by #Cruncher »

Rick Ferri wrote:At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater.
So far so good.
Rick Ferri wrote:Original principal is it's price ratio to par value at issuance (quoted as a price; 102.3, 100.8, etc).
But this is not the correct meaning of "original principal".

At original issuance a TIPS purchaser pays an amount equal to the
  • face value X
  • the original inflation adjustment factor X
  • the unadjusted price
The product of the first two terms is the "original principal", not the product of all three. For example, here are the figures for an assumed $1,000 face value purchase based on the auction results PDF file for the original issue of the 5-year TIPS maturing April 2018 that I mentioned in my previous post:

Code: Select all

$1,000.00       face value
     1.00408    original inflation adjustment factor [ 1 ]
------------
$1,004.08       original principal = face value X original inflation adjustment factor
   107.382589%  unadjusted price
--------------
$1,078.2071     total cost = original principal X unadjusted price
The original principal in this case is $1,004. And only this, not the total $1,078 purchase price is all the Treasury promises to pay as a minimum at maturity. [ 2 ]
  1. The 1.00408 original inflation adjustment factor reflects the increase in the Reference Consumer Price Index between the 4/15/2013 Dated Date of the TIPS and the 4/30/2013 Issue Date. (1.00408 = 232.10313 on 4/30/2013 divided by 231.16013 on 4/15/2013. See Ref CPI for 2013.)
  2. I'm assuming that $1,004.08 is what the Treasury means by "original principal". ( According to the FAQ What happens to TIPS if deflation occurs?: ... at maturity, if the adjusted principal is less than the security's original principal, you are paid the original principal.) But it's possible the Treasury may mean that the $1,000 face value is the "original principal" and that is the minimum it guarantees to pay. Since no TIPS has ever suffered a decline in the CPI over its life, there has been no actual case to decide the correct interpretation.
Edit: removed my comment about using the term "principal" instead of "par value".
Last edited by #Cruncher on Mon Sep 29, 2014 10:33 pm, edited 1 time in total.
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Re: TIPS & Rick Ferri

Post by asif408 »

Rick Ferri wrote:
larryswedroe wrote:fwiw
The BIGGEST advantage of TIPS IMO is that they allow you to earn the term premium without taking inflation risk
Larry
Good point. On the flip-side,TIPS add deflation risk. Prices fall causing the par value of TIPS to fall, although they will never mature below their original issue price.

Rick Ferri
Rick & Larry,

Do either of you recommend owning individual TIPS over TIPS funds? I don't currently own any TIPS but plan to add some down the road. From my readings I lean towards purchasing individual TIPS because of the deflation protection vs. the TIPS fund (which if I understand correctly doesn't necessarily protect against deflation), but then you can't easily reinvest the dividends in individual TIPS. I was curious where you both stand on owning individual TIPS vs TIPS funds.

By the way, I appreciate all the knowledge you guys provide for the average investor out there.
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Re: TIPS & Rick Ferri

Post by Rick Ferri »

asif408 wrote: Rick & Larry,

Do either of you recommend owning individual TIPS over TIPS funds?
I own a fund because I don't want to bother managing a TIPS portfolio and dealing with interest payments. But that doesn't mean one is better than the other. The strategy you use should suit your needs and willingness to maintain the discipline.

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Re: TIPS & Rick Ferri

Post by dkturner »

larryswedroe wrote:fwiw
The BIGGEST advantage of TIPS IMO is that they allow you to earn the term premium without taking inflation risk
Larry
But, what happens to long dated TIPS when interest rates rise with no rise in the underlying inflation rate? Hint: in 2013 the CPI rose only 1.5% (vs a 1.7% increase the year before) but long dated TIPS declined precipitously in price, because they have a much longer duration than comparable maturity regular Treasuries. What would happen if an investor held intermediate-term Treasuries and converted to long dated TIPS only after a substantial increase in CPI?
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Re: TIPS & Rick Ferri

Post by abuss368 »

asif408 wrote: Rick & Larry,

Do either of you recommend owning individual TIPS over TIPS funds? I don't currently own any TIPS but plan to add some down the road. From my readings I lean towards purchasing individual TIPS because of the deflation protection vs. the TIPS fund (which if I understand correctly doesn't necessarily protect against deflation), but then you can't easily reinvest the dividends in individual TIPS. I was curious where you both stand on owning individual TIPS vs TIPS funds.

By the way, I appreciate all the knowledge you guys provide for the average investor out there.
Hi asif408,

I would except there to be no difference between individual TIPS and TIPS funds over time. Both investments would have the same expected returns. Your strategy should be one that you can manage and stay with over time. I prefer the simplicity of a fund rather than individual bonds.

Best.
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Re: TIPS & Rick Ferri

Post by Doc »

Rick Ferri wrote:At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. Original principal is it's price ratio to par value at issuance (quoted as a price; 102.3, 100.8, etc). This provision protects you against deflation if you buy a bond at issuance.
The yield difference in the on the run TIPS and its adjacent off the run issues during the deflation fears following the Lehman collapse may be a good example of the "buy at issuance" qualification.
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Re: TIPS & Rick Ferri

Post by abuss368 »

Doc wrote:
Rick Ferri wrote:At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. Original principal is it's price ratio to par value at issuance (quoted as a price; 102.3, 100.8, etc). This provision protects you against deflation if you buy a bond at issuance.
The yield difference in the on the run TIPS and its adjacent off the run issues during the deflation fears following the Lehman collapse may be a good example of the "buy at issuance" qualification.
Hi Doc,

Do you invest in the Vanguard TIPS fund?

This has been a good thread.
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Re: TIPS & Rick Ferri

Post by Doc »

abuss368 wrote:Hi Doc,

Do you invest in the Vanguard TIPS fund?
No.

Short term fund: I don't see any benefit from short term TIPS. The risk of unexpected inflation in the short term is low simply because we should be able to predict inflation fairly well in the near term. Further the penalty for that risk actually occurring is small because the notes mature soon and we can reinvest.

Intermediate term fund: As a general policy I don't invest in long bonds or funds that hold long bonds like the TIPS fund or TBM. That being said if long term real rates are attractive compared to historic levels I would buy long Treasuries and I would use TIPS because unlike the short term the risk of unexpected inflation is greater and the penalty of that risk happening is also greater. But I would buy individual bonds not the fund because I want to control my duration and have the ability to place short fixed income separately for better tax efficiency.
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Re: TIPS & Rick Ferri

Post by Call_Me_Op »

Since we are talking about TIPS, is anyone aware of ETFs that invest in TIPS having a series of defined maturity dates? If so, this might be a good way to build a TIPS ladder in taxable while circumventing the "phantom income problem?" I know it wouldn't solve the tax problem per se (nothing totally solves that except for zero tax rate), but would solve the cash-flow issue.
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Re: TIPS & Rick Ferri

Post by Doc »

Call_Me_Op wrote:... circumventing the "phantom income problem?"
Do we ever worry about the "phantom reinvestment of dividends problem"?
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Re: TIPS & Rick Ferri

Post by Call_Me_Op »

Doc wrote:
Call_Me_Op wrote:... circumventing the "phantom income problem?"
Do we ever worry about the "phantom reinvestment of dividends problem"?
Can you clarify?
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Re: TIPS & Rick Ferri

Post by Doc »

Call_Me_Op wrote:
Doc wrote:
Call_Me_Op wrote:... circumventing the "phantom income problem?"
Do we ever worry about the "phantom reinvestment of dividends problem"?
Can you clarify?
A lot of us reinvest dividends. If so we have to pay taxes on money we never get in the year the taxes are paid. The OID has the same effect. You have to pay taxes on income you don't receive in the year the taxes are paid. Yet we think about reinvested dividend as a good thing but "reinvestment" of the inflation component of the TIPS return as bad - ie "phantom income".

TIPS "phantom income" is a "red herring". :)
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Re: TIPS & Rick Ferri

Post by Call_Me_Op »

Doc,

Good point. The difference is that you are not normally "forced" to reinvest the dividend, and if you were to need it to pay taxes it could be used for such. But good point nonetheless.
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Re: TIPS & Rick Ferri

Post by dbr »

This reinvestment thing is not just about TIPS. If a person wants a nominal bond position to increase in value to pace inflation, one would have to be continually adding to the principal as well. The difference is that the nominal bond may not even pay enough to fund the reinvestment and additional money would have to come from somewhere else. In the meantime one is still paying taxes on everything distributed, just like TIPS (added to the bond or, in a fund, paid out). TIPS are actually a little less a tax burden than most nominal bonds because they are exempt from state income taxes.
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Re: TIPS & Rick Ferri

Post by Call_Me_Op »

The topic of "phantom income" is of interest to me because the only place I have available for TIPS is my taxable account. I currently hold a small number of TIPS there - and will add if real rates become attractive.
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Re: TIPS & Rick Ferri

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Call_Me_Op wrote:The topic of "phantom income" is of interest to me because the only place I have available for TIPS is my taxable account. I currently hold a small number of TIPS there - and will add if real rates become attractive.
Just remember that it is a cash flow problem not a return problem as in "I pay more taxes".

Whether or not you have TIPS in a taxable account depends on tax efficiency and your alternatives. Remember tax (in)efficiency is the amount lost to taxes which is tax rate times taxable return. With the current low taxable return on Treasuries and the state tax exemption TIPS in a taxable account may be more tax efficient then many common recommendations for a lot of us. It is not a "phantom income" problem.
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Re: TIPS & Rick Ferri

Post by abuss368 »

Hi Doc,

Excellent points regarding "phantom income" and the taxation of TIPS in general. Rick Ferri has noted before that TIPS are fine in a taxable account as a result of the state and local tax benefits. Combined with a tax exempt bond fund, this may be a good choice. Any other bonds funds such as Total Bond Index, Total International Bond, etc. are paying Federal, State, and Local taxes.

Best.
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Re: TIPS & Rick Ferri

Post by Johm221122 »

hoops777 wrote:If one has 20000 a year to invest in tips or ibonds for a husband and wife which is the better choice?
Tips are not tax efficient
I bonds can't be bought in ira
20k is over ira contributions limit for couple
Unless I'm missing something :?: I bonds it is
John
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