30 year tips auction: TBA 2/12 0.75% yield?

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grok87
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30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

So the next 30 year tips auction will be announced on February 12th. At that time you should be able to place orders with Vanguard, etc.

The current real yield on the 29 year TIP is about 0.60%. The new 30 year tips will be a year longer, plus there is usually some extra yield from buying at auction. I'm hopeful that we will get a 0.75% yield but we will see.

Anyone else buying? I will be in for my usual thrice-yearly amount as the yield will hopefully be over my minimum required yield of 0.52% (a somewhat arbitrary 1 bp a week).

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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

29 year tips yield now at 0.68%. so 0.75% is looking good for the auction...
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Hi grok, I'm on board with you for 1/3 of my annual purchase as well.

I found your idea of a 0.52% floor interesting. I don't have a rule to fall back on, yet, although I have a hunch that I'll probably just follow rates down wherever they go and keep buying. I don't mind skipping one of the 3 auction/reopening opportunities, but I still want to buy the balance by the last reopening of each year. My annual purchase only covers about 20% of my expected minimum living needs, and given that SS & pension will very likely cover everything anyhow, it's not a huge commitment. I don't like the idea though that I can really know at what point real rates are unacceptable for the purposes of matching 20% of my expected future liabilities, so I'm thinking that it's at least more logically consistent to just commit and buy whatever may happen. At least this is easier since my purchases are not especially large.

Btw, here's a recent post from Nisi in another thread that effectively highlights how little I feel I have a right to think I might know where interest rates are heading, let alone what's an acceptable vs unacceptable real rate for my 20% LMP ladder.

Nonetheless, here's to rising rates over the next 2 weeks! :beer
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

Angst wrote:Hi grok, I'm on board with you for 1/3 of my annual purchase as well.

I found your idea of a 0.52% floor interesting. I don't have a rule to fall back on, yet, although I have a hunch that I'll probably just follow rates down wherever they go and keep buying. I don't mind skipping one of the 3 auction/reopening opportunities, but I still want to buy the balance by the last reopening of each year. My annual purchase only covers about 20% of my expected minimum living needs, and given that SS & pension will very likely cover everything anyhow, it's not a huge commitment. I don't like the idea though that I can really know at what point real rates are unacceptable for the purposes of matching 20% of my expected future liabilities, so I'm thinking that it's at least more logically consistent to just commit and buy whatever may happen. At least this is easier since my purchases are not especially large.

Btw, here's a recent post from Nisi in another thread that effectively highlights how little I feel I have a right to think I might know where interest rates are heading, let alone what's an acceptable vs unacceptable real rate for my 20% LMP ladder.

Nonetheless, here's to rising rates over the next 2 weeks! :beer
Yes, hopefully this trend will continue.

As far as the 0.52% I agree it is a bit arbitrary. I'm a big David Swensen fan. I think his argument is that you should have a well diversified portfolio with an expected positive real returns. So in some sense the minimum real return could be zero. But i just think 30 years is too long a period of time to lock up money at say a 0.1% or 0.2% real rate. It might be ok for an institutional investor.

As with much in life, the actual 0.52% might not be as important as just picking a number and sticking to it.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by tipswatcher »

The Treasury issues a daily estimate of real yields, which translate to TIPS yields, and it's usually pretty accurate:

http://www.treasury.gov/resource-center ... =realyield

At the close Friday the 30-year real yield was 0.68%, up 14 basis points in a week. That's a positive trend.

I will warn that if you buy a 30-year TIPS in a taxable account, you face the danger of being cash-flow negative until maturity. That is 30 years, a long time to get the cash back. The coupon rate of 0.5% might not cover the taxes due each year on the inflation adjustment.

Let's say inflation runs 2% over the next 30 years. You buy $10,000 of this TIPS, and it has a coupon rate of 0.50% (which it will be unless the yield to maturity auctions higher than 0.75%). You will be earning $50 a year from the coupon (growing with inflation). If inflation rises 2%, you will get a taxable adjustment to principal of $200 (growing with inflation). If you are in a 28% tax bracket you will owe $70 in taxes on the $250 in interest, but you only got $50 from the coupon rate.

This will get worse if inflation rises above 2%. Also, worse if your tax bracket is higher than 28%.

30-year TIPS with low coupon rates are not a good deal in a taxable account.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

tipswatcher wrote:The Treasury issues a daily estimate of real yields, which translate to TIPS yields, and it's usually pretty accurate:

http://www.treasury.gov/resource-center ... =realyield

At the close Friday the 30-year real yield was 0.68%, up 14 basis points in a week. That's a positive trend.

I will warn that if you buy a 30-year TIPS in a taxable account, you face the danger of being cash-flow negative until maturity.
i always keep my tips in a tax-advantaged account. i am basically buying them for inflation insurance. if i hold them in taxable account and we get double digit inflation (ala the late 70s early 80s stagflation) then i will get killed on taxes if they are in a taxable account...
Last edited by grok87 on Sun Feb 08, 2015 10:42 pm, edited 1 time in total.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by #Cruncher »

tipswatcher in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2365896#p2365896]this post[/url] wrote:I will warn that if you buy a 30-year TIPS in a taxable account, you face the danger of being cash-flow negative until maturity. ... The coupon rate of 0.5% might not cover the taxes due each year on the inflation adjustment. ... 30-year TIPS with low coupon rates are not a good deal in a taxable account.
What you say is true, tipswatcher. But I think you're making a mountain out of a molehill. There are good reasons not to hold TIPS in a taxable account -- perhaps the best is the one grok87 mentions and I discuss below -- but, in my opinion, this isn't one of them. In almost all cases, one can easily come up with money to pay the tax shortfall from other assets one holds. We're not talking about a lot of money --unless the CPI increase is staggering. And furthermore, the "cash flow problem" doesn't go away by buying TIPS with a higher coupon, as one might conclude from your warning.

Consider first your example of purchasing $10,000 face value of a 0.5% coupon 30-year TIPS. Assume the yield is also 0.5% so the purchase is at par. Also assume the CPI rises 2% every year and that one is in the 28% federal tax bracket. Here are the interest, CPI adjustment (aka OID), taxes and net cash flow every year and in total for the 30 years. (For simplicity, I'm assuming interest is paid at the end of each year instead of semi-annually.)

Code: Select all

Years  Mkt Value  CPI Factor  Coup Amt    Amort   Adj Princ     OID        Tax   Cash Flow
-----  ---------  ----------  --------   ------   ---------    ------     -----  ---------
  30   10,000.00    1.00000                       10,000.00                              
  29   10,000.00    1.02000     51.00             10,200.00    200.00     70.28    (19.28)
  28   10,000.00    1.04040     52.02             10,404.00    204.00     71.69    (19.67)
  27   10,000.00    1.06121     53.06             10,612.08    208.08     73.12    (20.06)
...
   3   10,000.00    1.70689     85.34             17,068.86    334.68    117.61    (32.26)
   2   10,000.00    1.74102     87.05             17,410.24    341.38    119.96    (32.91)
   1   10,000.00    1.77584     88.79             17,758.45    348.20    122.36    (33.57)
   0   10,000.00    1.81136     90.57             18,113.62    355.17    124.81    (34.24)
                             --------                        --------  --------   --------
Total                        2,068.97                        8,113.62  2,851.12   (782.15)
As you state, the interest collected ($51 in first year) isn't enough to pay the tax ($70.28) on the total taxable income including the $200 OID (70.28 = 28% X 251). One needs to come up with an additional $19.28 to pay the tax. This increases each year, so that in total for 30 years the shortfall is $782.15.

Now consider the case where the TIPS coupon is large enough to fund the tax. Let the coupon be 1% instead of 0.5%. Here are the comparable figures for this case. Note that I'm assuming the yield is still only 0.5%. This means that one has to pay a substantial premium to par value to purchase this TIPS.

Code: Select all

Years  Mkt Value  CPI Factor  Coup Amt    Amort   Adj Princ     OID        Tax   Cash Flow
-----  ---------  ----------  --------   ------   ---------    ------     -----  ---------
  30   11,389.70    1.00000                       10,000.00                              
  29   11,346.65    1.02000    102.00     43.05   10,200.00    200.00     72.51     29.49
  28   11,303.38    1.04040    104.04     43.27   10,404.00    204.00     74.14     29.90
  27   11,259.90    1.06121    106.12     43.48   10,612.08    208.08     75.80     30.32
...
   3   10,148.51    1.70689    170.69     49.01   17,068.86    334.68    127.78     42.91
   2   10,099.25    1.74102    174.10     49.26   17,410.24    341.38    130.54     43.56
   1   10,049.75    1.77584    177.58     49.50   17,758.45    348.20    133.36     44.22
   0   10,000.00    1.81136    181.14     49.75   18,113.62    355.17    136.24     44.90
                             --------  --------              --------  --------  --------
Total                        4,137.94  1,389.70              8,113.62  3,041.32  1,096.62
In this case the 1% coupon provides twice the cash each year as the 0.5% coupon and this is enough to fund the taxes due on the interest (net of amortization) plus OID. [ E.g., in the first year the tax is $72.51 = 28% X (102.00 - 43.05 + 200.00). ] But notice the significant premium to par. One has to pay a premium of $1,390 for $10,000 face value of this TIPS compared to the TIPS with the smaller coupon that sold at par. This is more of a "cash flow problem" than coming up with an average of only $25 per year over 30 years.

Of course both "problems" would go away if the yield -- not just the coupon -- were higher. E.g., a TIPS with a 1% coupon that yielded 1% could be purchased at par and would also provide enough cash to pay the taxes in a 28% bracket and a 2% annual CPI increase. E.g., in year one the tax of $84.56 (28% X $302) would be covered by the $102 interest collected.
tipswatcher in same post wrote: ...it has a coupon rate of 0.50% (which it will be unless the yield to maturity auctions higher than 0.75%).
Treasury Note and Bond (including TIPS) Coupons are set in 1/8% increments. And the coupon is set equal to or less than the yield so the price will either be at par or slightly below. So, for example, a TIPS with an auction yield of at least 0.5% but less than 0.625% would get a 1/2% coupon; and one with an auction yield of at least 0.625% but less than 0.75% would get a coupon of 5/8%. (There is a minimum coupon of 1/8%. Therefore if the auction yield is less than 0.125%, the TIPS will sell at a premium.)
grok87 in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2367671#p2367671]this post[/url] wrote:if i hold [ TIPS ] in taxable account and we get double digit inflation ... then i will get killed on taxes if they are in a taxable account...
Quite so. If held in a Traditional or Roth IRA, the after tax real return from individual TIPS or a TIPS fund in unaffected by how much the CPI rises. But if held in a taxable account, it decreases the more the CPI rises. For example see my post, Re: Creating more TAX-ADVANTAGED space for "HNW" TIPS...idea.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by tarnation »

Thought you might find this paper interesting "Are Treasury Inflation Protected Securities Really Tax Disadvantaged?"
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by tipswatcher »

#Cruncher ... I can be a moron at times, and my error on the 0.625% versus 0.750% proves it yet again.

As of Friday, the real yield on a 30-year TIPS had risen to 0.68%, which would get that 0.625% coupon rate, and put the TIPS fairly close to cash-flow neutral, depending on the inflation rate, of course. Still, I'd like to see a 30-year TIPS yielding somewhere near 2%. Then I could get interested as a buy-and-hold investment. But alas, I am getting too old to plan out 30 years of survival.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

29 year tip yield @ 0.745%. looks like my yield forecast of 0.75% for the 30 year auction may be too low!

1% here we come???
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by dkturner »

grok87 wrote:29 year tip yield @ 0.745%. looks like my yield forecast of 0.75% for the 30 year auction may be too low!

1% here we come???
Remember at auction the coupon yield is rounded down and the bonds is sold at a discount. If the non-competitive yield at the auction is .74 the resulting coupon will be 5/8 of 1%. To get a 3/4 of 1% coupon the auction yield has to be .75 or higher.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by #Cruncher »

Here is the Offering Announcement released Thursday. It shows the auction will be next Thursday 2/19/2015 and the issue date (i.e., settlement date) will be Friday 2/27/2015. The Treasury will offer $9 billion, the same amount as in the initial 30-year TIPS auction for the past few Februaries. (See 30-year TIPS auctions.)

The yield can be estimated by looking at the five outstanding bonds maturing 2040-2044 that were issued since the Treasury resumed 30-year TIPS in 2010 (I've also included the April 2029 TIPS for comparison.) Here are the yield to maturity, Macaulay duration, and price sensitivity based on the WSJ TIPS Quotes 2/13/2015. [ * ]

Code: Select all

                              Macaulay  Fall if Yld
  Matures    Coupon   Yield   Duration  Rises 1% Pt
----------   ------   ------  --------  -----------
04/15/2029   3.875%   0.573%    11.5       10.9%
02/15/2040   2.125%   0.759%    20.3       18.1%
02/15/2041   2.125%   0.759%    21.0       18.6%
02/15/2042   0.750%   0.807%    24.5       21.4%
02/15/2043   0.625%   0.803%    25.7       22.3%
02/15/2044   1.375%   0.790%    24.4       21.3%
02/15/2045   0.750%   0.820%    26.9       23.2%
It's unclear which outstanding maturity provides the best guide as to what the yield will be on the new 2045 issue. The 2044 TIPS obviously is the closest in maturity with 29 years to run. But since the new issue will likely have a lower coupon than the 2044, its duration will probably be closer to the 0.625% 2043 TIPS maturing in 28 years. But this question is largely academic since the TIPS yield curve has gotten pretty shallow recently. There isn't much difference in yield between the 2042, 2043, and 2044 maturities. I'm guesstimating a yield of 0.82% for the new issue if rates are at current levels at the time of the auction.

I've included the 3.875% April 2029 TIPS in the table above to show that the 30-year TIPS will have much more interest rate risk. For example, should yields rise 1% point, the April 2029 will fall in price only about 11%. But the new 2045 TIPS will be much more sensitive to higher interest rates. If it should come in with a 0.75% coupon and then if interest rates should jump 1% point, its price would fall about 23%. For assuming twice the interest rate risk, one is likely to be rewarded with a yield only 1/4% point higher (0.82% - 0.57%). If one is concerned about long-term TIPS rates falling even lower, one might still want to lock in this historically low 30-year rate. But if one is more concerned about long-term TIPS rates rising, it might make sense to invest in a shorter maturity at this time.

* Duration and price sensitivity are calculated using the Excel DURATION and PRICE functions. For example, here are the computations for the Feb 2044 maturity:

Code: Select all

   24.4  =DURATION(DATE(2015, 2, 16), DATE(2044, 2, 15), 1.375%, 0.79%,      2, 1)
  115.1  =PRICE(   DATE(2015, 2, 16), DATE(2044, 2, 15), 1.375%, 0.79%, 100, 2, 1)
   90.6  =PRICE(   DATE(2015, 2, 16), DATE(2044, 2, 15), 1.375%, 1.79%, 100, 2, 1)
  -21.3% =90.6 / 115.1 - 1
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Chuck »

Indicative Yield on Vanguard's site says 0.814% as of today. I will be almost 70 when this matures...
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

Chuck wrote:Indicative Yield on Vanguard's site says 0.814% as of today. I will be almost 70 when this matures...
I agree, at some point one needs to start taking one's age into consideration. Personally I think i will scale back my buying as i approach retirement and stop buying when i hit 65. I think planning for the contingency of living to 95 is good enough...
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Chuck wrote:Indicative Yield on Vanguard's site says 0.814% as of today. I will be almost 70 when this matures...
At Vanguard it now shows 0.860%. Nice to see rates rising as the auction approaches.
grok87 wrote:I agree, at some point one needs to start taking one's age into consideration. Personally I think i will scale back my buying as i approach retirement and stop buying when i hit 65. I think planning for the contingency of living to 95 is good enough...
Grok, it almost seems to go without saying that a LMP portfolio of TIPS ought to be purchased out to one's life expectancy, and I can understand the inclination to taper off at the end of the timeframe. Here's one thing that occurs to me about erroring on the side of living 5-10 yrs longer than what the tables suggest is needed: My little insight is that as you age, you will gradually have a better idea of how many more years you have, and certainly one better than what one can have while still in their 50's or 60's. If at age 80, 85 or 90 (whatever) you find death's door coming into focus, or at least you can begin to foresee fairly clearly a certain number of days/months/yrs left, you still can then make the choice to sell some of the longest remaining TIPS. You're not obliged to leave them to the estate intact and they might help buffer some of the uncertainties about expenses towards the end. Do you think at all about your TIPS holdings in this context?
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

Angst wrote:
Chuck wrote:Indicative Yield on Vanguard's site says 0.814% as of today. I will be almost 70 when this matures...
At Vanguard it now shows 0.860%. Nice to see rates rising as the auction approaches.
grok87 wrote:I agree, at some point one needs to start taking one's age into consideration. Personally I think i will scale back my buying as i approach retirement and stop buying when i hit 65. I think planning for the contingency of living to 95 is good enough...
Grok, it almost seems to go without saying that a LMP portfolio of TIPS ought to be purchased out to one's life expectancy, and I can understand the inclination to taper off at the end of the timeframe. Here's one thing that occurs to me about erroring on the side of living 5-10 yrs longer than what the tables suggest is needed: My little insight is that as you age, you will gradually have a better idea of how many more years you have, and certainly one better than what one can have while still in their 50's or 60's. If at age 80, 85 or 90 (whatever) you find death's door coming into focus, or at least you can begin to foresee fairly clearly a certain number of days/months/yrs left, you still can then make the choice to sell some of the longest remaining TIPS. You're not obliged to leave them to the estate intact and they might help buffer some of the uncertainties about expenses towards the end. Do you think at all about your TIPS holdings in this context?
It's a good question, i'll think about it. My gut reaction is that I would plan more like 15-20 years beyond one's life expectancy.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Doc »

grok87 wrote:It's a good question, i'll think about it. My gut reaction is that I would plan more like 15-20 years beyond one's life expectancy.
I think I've said this before but ...

I use only ten years into retirement with the intent of using the TIPS only in the case when the stock market tanks during that time. That way I don't have to deplete my equity to an unknown extent for those ten years. If the market recovers in five I start replacing the TIPS I "used up". In this way I get nearly the same LMP effect but don't have to accept the current very low real rates for thirty years.

Of course in the market tanks for twenty years I may wish that I had used grok's approach instead.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

grok87 wrote:
Angst wrote:
Chuck wrote:Indicative Yield on Vanguard's site says 0.814% as of today. I will be almost 70 when this matures...
At Vanguard it now shows 0.860%. Nice to see rates rising as the auction approaches.
grok87 wrote:I agree, at some point one needs to start taking one's age into consideration. Personally I think i will scale back my buying as i approach retirement and stop buying when i hit 65. I think planning for the contingency of living to 95 is good enough...
Grok, it almost seems to go without saying that a LMP portfolio of TIPS ought to be purchased out to one's life expectancy, and I can understand the inclination to taper off at the end of the timeframe. Here's one thing that occurs to me about erroring on the side of living 5-10 yrs longer than what the tables suggest is needed: My little insight is that as you age, you will gradually have a better idea of how many more years you have, and certainly one better than what one can have while still in their 50's or 60's. If at age 80, 85 or 90 (whatever) you find death's door coming into focus, or at least you can begin to foresee fairly clearly a certain number of days/months/yrs left, you still can then make the choice to sell some of the longest remaining TIPS. You're not obliged to leave them to the estate intact and they might help buffer some of the uncertainties about expenses towards the end. Do you think at all about your TIPS holdings in this context?
It's a good question, i'll think about it. My gut reaction is that I would plan more like 15-20 years beyond one's life expectancy.
Just had a look at the ssa life tables. Based on that, for a 65 year old man the 95th percentlie of age at death is 96 years old.
For a 65 year old woman the 95th percentile of age at death is 99 years.

So if you want to be 95. Percent certain of not outliving your tips, a man would stop buying tips at age 66 and a wiman at age 69 (roughly).

The ssa tables probably are too short, ie show people dying sooner than may be the case going forward, on average.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Doc »

grok87 wrote:Just had a look at the ssa life tables. Based on that, for a 65 year old man the 95th percentlie of age at death is 96 years old.
For a 65 year old woman the 95th percentile of age at death is 99 years.

So if you want to be 95. Percent certain of not outliving your tips, a man would stop buying tips at age 66 and a wiman at age 69 (roughly).

The ssa tables probably are too short, ie show people dying sooner than may be the case going forward, on average
So this is the run out of money and die 95% of the time approach to determining the size of one's retirement portfolio that is needed. :D
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

Doc wrote:
grok87 wrote:Just had a look at the ssa life tables. Based on that, for a 65 year old man the 95th percentlie of age at death is 96 years old.
For a 65 year old woman the 95th percentile of age at death is 99 years.

So if you want to be 95. Percent certain of not outliving your tips, a man would stop buying tips at age 66 and a wiman at age 69 (roughly).

The ssa tables probably are too short, ie show people dying sooner than may be the case going forward, on average
So this is the run out of money and die 95% of the time approach to determining the size of one's retirement portfolio that is needed. :D
Yes. I agree it may not be the best approach for everybody.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Doc »

Grok, why set up your ladder ahead of time? The day after you retire buy your 30 year TIPS ladder on the secondary market. Hopefully rates will be higher then and you will get a higher income going forward. In any case you should be able to earn more than 1% real in the meantime while you are still working and have some choices left. When you buy a 30 year Treasury you are stuck with that fixed income for 30 years unless you sell it and buy something more risky and that is not in keeping with the risk free LMP philosophy that was the premise for the whole idea.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Doc wrote:Grok, why set up your ladder ahead of time? The day after you retire buy your 30 year TIPS ladder on the secondary market. Hopefully rates will be higher then and you will get a higher income going forward. In any case you should be able to earn more than 1% real in the meantime while you are still working and have some choices left. When you buy a 30 year Treasury you are stuck with that fixed income for 30 years unless you sell it and buy something more risky and that is not in keeping with the risk free LMP philosophy that was the premise for the whole idea.
Doc, here's my rationale: I expect that SS & DB pension will cover something slightly over my anticipated bare-minimum needs or expenses at retirement. I'm purchasing TIPS annually to cover an additional 20% of these anticipated minimum expenses. Why cover over 100%? Well... why not? I can't be sure of what will come or of the accuracy of my expense projections, and my DB pension is not COLA'ed. Moreover, I ultimately expect to spend more than my safety floor or "bare-minimum" expenses and I just feel better having the 20% cushion to start with. I also find it useful to conceptualize minimum and desired expenditures separately. For me, "desired" is simply more than the "minimum"; I haven't set a specific number and I expect to simply spend as can/want to spend, so to speak. Of course this will depend on the state of my equity portfolio. Anyhow, more to your point: My equity/FI ratio has been about 85/15 for most of my adult life and given my current employment income and my anticipated SS/DBP retirement funding floor, buying TIPS annually barely even keeps my FI balance at 15%. As such, I find the notion of simply growing into my full retirement base of FI with TIPS as comforting and easy to do. If I didn't do this I'd still want to hold my FI at 15%, so it's really more of a TIPS vs TBM issue for me than TIPS vs. equity. Does this sound reasonable?
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Doc »

Angst wrote:If I didn't do this I'd still want to hold my FI at 15%, so it's really more of a TIPS vs TBM issue for me than TIPS vs. equity. Does this sound reasonable?
It must be reasonable since I do something very similar except for the maturity of the TIPS. The TBM/TIPS tradeoff is also reasonable. My question to grok was not whether or not to have a thirty year TIPS ladder in retirement but rather when you should establish that ladder. grok is apparently setting up the ladder during his working years. For whatever time he has left before retirement he is giving up yield for thirty years. Keep that money in TBM for the next ten years or whatever the time remaining is and then establish your ladder all at one time on the secondary market. We expect rates to be higher in the medium term not lower so you gain something. If the situation is actually worse at retirement age you can always work a little longer if needed. Establishing a very risk free but also very low return LMP now when you can easily wait for better market conditions just makes a lot of sense to me.

Rational thinking suggests that when interest rates are below historical norms they are more likely to go up than down and visa versa. No guarantee of course. But locking in a historically very low rate for 30 years when you have good alternatives to establish you LMP later just doesn't seem like a rational exercise. It is more some kind of "fear" that buying Treasuries on the secondary market is somehow much more risky or expensive than buying them at auction.

I have no problem with TIPS - just with long TIPS at 1% real. I'm buying a double TIPS rung of fives at the April auction but we are already retired. I'm also (re)establishing my LMP but for only ten years and only for use during times of very adverse stock market conditions will it ever be used. During "normal" market conditions my 40/60 portfolio should suffice. (The TIPS ladder is included in the 60 not an additional amount.) Additionally I'm planning on being one of those five percent who outlive the mortality tables and I hate to eat dogfood.

As an aside if I had a 85/15 AA my fixed income would probably be in all long nominal Treasuries. With that high an equity ratio practically all your return is from the equity portion and the reason to have FI at all is not for the interest payments but to buy more stock in that inevitable bear market whenever that day comes.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Doc wrote:Rational thinking suggests that when interest rates are below historical norms they are more likely to go up than down and visa versa. No guarantee of course. But locking in a historically very low rate for 30 years when you have good alternatives to establish you LMP later just doesn't seem like a rational exercise.
Doc, thank you for your comments. I think I understand what you're saying, and not to be argumentative, I still would like to ask you something more. If one is satisfied with the overall duration of their FI portfolio, does it matter whether it's all in TBM, or if they're gradually accumulating 30-year TIPS while balancing their FI with shorter-term securities? For a 35-year old patient in particular, that first 30-year purchase/rung of TIPS might barely make a dent in their overall FI duration. As they accumulate TIPS rungs over time, the prior TIPS become shorter, while the entirety of their bond holdings might still be growing, adding ballast to the intermediates, and they could also be shifting some non-TIPS FI to shorter durations. I bring this up because if it is a reasonable alternative (at least hypothetically, turning back the hands of time for some of us), would it not also be a good thing to eliminate the risk that thirty years out (for that 35-year old) it might not actually be a great time for buying an entire 30-year TIPS ladder? I understand your point about the context of our current low rate environment, and of your situation in particular, but perhaps at least for a 35-year old today, is not their overall FI portfolio duration what matters most rather than its specific components? Either way, I wouldn't mind being 35 again.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

Doc wrote:
Rational thinking suggests that when interest rates are below historical norms they are more likely to go up than down and visa versa. No guarantee of course. But locking in a historically very low rate for 30 years when you have good alternatives to establish you LMP later just doesn't seem like a rational exercise. It is more some kind of "fear" that buying Treasuries on the secondary market is somehow much more risky or expensive than buying them at auction.

I have no problem with TIPS - just with long TIPS at 1% real.
1) I've posted on this before, but historically 1% real has not been that bad of a bond return. THe recent period of high real interest rates was a bit of an anomaly. Will try to find the reference. it was a study by deutsche bank on 100+ years of corporate bond returns (they showed treasury data also).

2) i'm also doing this to cover minimum retirement needs. i don't have any sort of pension coming to me (actually i have a tiny one that is barely worth speaking of).

3) To be honest i am a little worried about interest rates being so low. So i am pairing my 30 year tips purchases with purchases of LEAPs on the S&P 500. I'm probably due to do a post on the approach- it's not a new idea, Zvi Bodie has been advocating it. But I guess i have my own spin on how to do it.

cheers,
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Doc »

grok87 wrote:1) I've posted on this before, but historically 1% real has not been that bad of a bond return. THe recent period of high real interest rates was a bit of an anomaly. Will try to find the reference. it was a study by deutsche bank on 100+ years of corporate bond returns (they showed treasury data also).
The reference I used before was Krugman 54 Years Of Real Interest Rates http://krugman.blogs.nytimes.com/2013/0 ... ates/?_r=0

Also from Swedroe's bond book p225 "We begin by examining the historical real return on longer term bonds. for the period 1926-2004 longer-term Treasury bonds have provided a real return of 2.4 percent."
Angst wrote:If one is satisfied with the overall duration of their FI portfolio, does it matter whether it's all in TBM, or if they're gradually accumulating 30-year TIPS while balancing their FI with shorter-term securities?
Three problems:

1) I'm biased again due to Swedroe. I don't like long bonds at all and prefer the BarCap Intermediate (1-10) Gov/Credit Index to the BarCap Agg. That being said if I was going to buy long bonds they would be TIPS not nominals.

2) How do you calculate the nominal duration of a real return bond when you don't know the future inflation rate? And if you can't calculate the nominal duration how can you match the duration to TBM which is made up of all nominal bonds? So while your idea might work in theory I don't know how to make it work in the real world in practice.

3) The duration of the Agg index itself has gone up because of the Treasury issuing 30's instead of 20's in recent years. Possibly due to the borrower taking advantage of Federal Reserve action to decrease the Government's cost at the expense of the investor or on the other side to the benefit of the taxpayer. :shock:
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Artsdoctor »

I've made my peace with low real returns. And I've also realized that trying to predict where rates are headed is futile. I thought TIPS were cheap in 2008 and expensive in 2011 when I started building my LMP. I was right about 2008 but wrong about 2011--I'd still be waiting if I held out for 2.4% real returns.

Very few people can purchase an LMP all at once. It's possible, but it just seems unrealistic to buy a 20-year LMP on the day you turn 65. And you have absolutely no idea what real returns are going to be on that day. Remember that buying TIPS on the secondary market also is affected by demand, not just the accrued principal. If you're in the midst of unexpected inflation, everyone else is going to be wanting to buy TIPS.

If I'm buying my LMP in this environment, gradually, I accept that it's expensive to do so. But I'm not going to sell the LMP until I consume it, and I'm calculating that annual consumption in my retirement in today's dollars the best I can. I'll always have equities and nominals because I just don't have the space in my tax-advantaged accounts to build a gargantuan LMP, and this is something I view as a blessing and a curse. It's just the way things turned out.

If I have X now and want to spend X in the future, I'll buy something that yields X + CPI now. It's the best I can do. Let the equities do the heavy lifting and let the nominals help defray any deflationary periods. I've truly given up trying to time yields.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Doc »

Artsdoctor wrote: I'll always have equities and nominals because I just don't have the space in my tax-advantaged accounts to build a gargantuan LMP, and this is something I view as a blessing and a curse.
Check your math. Tax efficiency is the product of tax rate times the annual return. With 30 year TIPS returning maybe only 2.5% they are possibly more tax efficient than an S&P 500 fund for those taxpayers in the ~25% tax bracket.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Artsdoctor wrote:I've made my peace with low real returns. And I've also realized that trying to predict where rates are headed is futile. I thought TIPS were cheap in 2008 and expensive in 2011 when I started building my LMP. I was right about 2008 but wrong about 2011--I'd still be waiting if I held out for 2.4% real returns.

Very few people can purchase an LMP all at once. It's possible, but it just seems unrealistic to buy a 20-year LMP on the day you turn 65. And you have absolutely no idea what real returns are going to be on that day. Remember that buying TIPS on the secondary market also is affected by demand, not just the accrued principal. If you're in the midst of unexpected inflation, everyone else is going to be wanting to buy TIPS.

If I'm buying my LMP in this environment, gradually, I accept that it's expensive to do so. But I'm not going to sell the LMP until I consume it, and I'm calculating that annual consumption in my retirement in today's dollars the best I can. I'll always have equities ... [snip]

... It's the best I can do. Let the equities do the heavy lifting and let the nominals help defray any deflationary periods. I've truly given up trying to time yields.
+1
I'm pretty much in agreement with this perspective. For me, my relatively small DBP and small TIPS LMP complement SS and in total more than complete my bare minimum floor of living expenses (w/ approx. 120% total coverage). I'm comfortable with that, as well as with the remainder of my portfolio being largely dedicated to equity. I might continue purchasing long TIPS even into retirement if my total FI % threatens to drop below 15%. It could be a good problem to have to deal with; I might otherwise just have to spend down a bit more equity.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Doc wrote:
Angst wrote:If one is satisfied with the overall duration of their FI portfolio, does it matter whether it's all in TBM, or if they're gradually accumulating 30-year TIPS while balancing their FI with shorter-term securities?
Three problems:

1) I'm biased again due to Swedroe. I don't like long bonds at all and prefer the BarCap Intermediate (1-10) Gov/Credit Index to the BarCap Agg. That being said if I was going to buy long bonds they would be TIPS not nominals.

2) How do you calculate the nominal duration of a real return bond when you don't know the future inflation rate? And if you can't calculate the nominal duration how can you match the duration to TBM which is made up of all nominal bonds? So while your idea might work in theory I don't know how to make it work in the real world in practice.

3) The duration of the Agg index itself has gone up because of the Treasury issuing 30's instead of 20's in recent years. Possibly due to the borrower taking advantage of Federal Reserve action to decrease the Government's cost at the expense of the investor or on the other side to the benefit of the taxpayer. :shock:
Excellent points, thank you; how easily I just gloss over them. However, I do hold just 15% FI so longer bonds don't scare me so much. As far as the duration of my overall FI portfolio goes, I've long given up on accurately/precisely calculating it and just accept the fact that I'm making a general guess of what it is. I also hold a fair amount of I Bonds which I consider something of a counterweight to long TIPS, even though their value doesn't respond to the market and I'm not capable/willing to try to calculate their hypothetical effect on duration. I also gather that the duration of a growing LMP of TIPS is still going to gradually decline due to the aging of the already purchased bonds, and once accumulation ends, this would only accelerate. The overriding saving grace however is simply that I've always held a high % of equity and will continue to do so, so longer duration is not something I'm too concerned about. As an aside, at some point during decumulation, I'll probably need to begin moving some equity into intermediate bonds, at least if I haven't continued buying long bonds.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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Angst wrote: However, I do hold just 15% FI so longer bonds don't scare me so much.
If you have only 15% fixed income you might want to consider long nominal Treasuries. This is not something I look at but I think there are several advocates for this type of FI portfolio for those with high AA's. See Swenson maybe?

Unlike nominal Treasuries TIPS did very badly in the '08 market crash.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by grok87 »

auction yield was 0.842%, not bad!
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Angst »

Doc wrote:
Angst wrote: However, I do hold just 15% FI so longer bonds don't scare me so much.
If you have only 15% fixed income you might want to consider long nominal Treasuries. This is not something I look at but I think there are several advocates for this type of FI portfolio for those with high AA's. See Swenson maybe?

Unlike nominal Treasuries TIPS did very badly in the '08 market crash.
Point well-taken, although I willingly accept, to some degree at least, the notion that Lehman's dumping of TIPS might have contributed to this and that the quantity (relatively small) of outstanding TIPS at the time might also have contributed, both of which in combination might have further compounded the effect. It's just my own, fairly poorly substantiated interpretation, but I still lean towards the notion that TIPS will be less vulnerable in the future as both of these examples should hopefully become less likely to repeat over time. It doesn't bother me too much, but holding some long nominals might well be prudent. My nominals are currently limited to intermediates (fund's duration) and have been decreasing somewhat proportionately to my TIPS purchases.

Btw, today's auction results are in:
http://www.treasurydirect.gov/instit/an ... 0219_1.pdf

30 Year TIPS of 2045 CUSIP 912810RL4
Coupon 0.75%
High Yield 0.842%

[edit] Ooops, grok beat me to it!
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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Angst wrote:It's just my own, fairly poorly substantiated interpretation, but I still lean towards the notion that TIPS will be less vulnerable in the future as both of these examples should hopefully become less likely to repeat over time.
I think Larry Swedroe agrees with you at least on the Lehman dumping part. :sharebeer
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

Post by Artsdoctor »

Doc wrote:
Artsdoctor wrote: I'll always have equities and nominals because I just don't have the space in my tax-advantaged accounts to build a gargantuan LMP, and this is something I view as a blessing and a curse.
Check your math. Tax efficiency is the product of tax rate times the annual return. With 30 year TIPS returning maybe only 2.5% they are possibly more tax efficient than an S&P 500 fund for those taxpayers in the ~25% tax bracket.
That's correct. Certainly everyone should do the math and understand their own marginal tax rate. I can only dream of having a marginal tax rate of 25%. And don't forget that you're paying income tax on the appreciated principal as well as the coupon, for which you're really getting nothing (until the bond has matured or you've sold it). While some people might not mind the pay as you go philosophy, it's not prudent for me at this time. I will have to pay state income tax when I start withdrawing those TIPS from my tax-deferred accounts but that is many years from now and I'd like to think my marginal tax rate at that time will be lower (although I definitely wouldn't bet too much on that).
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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Artsdoctor wrote:And don't forget that you're paying income tax on the appreciated principal as well as the coupon, for which you're really getting nothing (until the bond has matured or you've sold it).
Right, that's why I said 2.5% ... 0.8 coupon + 1.8 inflation = 2.5%. (Ok it was a fast estimate.)

The deferral of the inflation income is not significant enough to worry about.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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^ For now. I've given up trying to predict the CPI for the foreseeable future. For me, I pick every transaction in my taxable account carefully because I don't want to be holding an investment in the future which creates a potentially significant tax liability. I personally don't want to be in a position where I'm holding TIPS in my taxable account should inflation get away from us; the thought of the CPI increasing 5% or more might seem unlikely now, but I can't imagine holding an asset where I'd be paying income tax on significantly increasing CPI of the principal itself.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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Artsdoctor wrote: For me, I pick every transaction in my taxable account carefully because I don't want to be holding an investment in the future which creates a potentially significant tax liability. I personally don't want to be in a position where I'm holding TIPS in my taxable account should inflation get away from us
If inflation runs away you simply sell the TIPS and buy the 500 in taxable and do the opposite in tax advantaged. There is no tax cost for the transaction. If you go the other way and inflation does not run away you can't do the same reversal because you have LTCG tax to pay on your equities. As long as the tax cost is the same based on what you know today put the bonds in taxable and the equities in tax advantaged. That way you keep your option open if things don't go as they seem to be today.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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^ Very reasonable. But you're setting yourself up to "have" to sell something, potentially creating yet another taxable event.

This is one of those situations that I can appreciate another person's viewpoint but it doesn't fit my needs to hold individual TIPS in my taxable account. One of the benefits I've found with putting together a LMP is that you can pretty much set it and forget it. Individual TIPS in a taxable account, for me, create more paperwork than I'm willing to accept but I can appreciate that obstacle being tiny for others.
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Re: 30 year tips auction: TBA 2/12 0.75% yield?

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Artsdoctor wrote: Individual TIPS in a taxable account, for me, create more paperwork than I'm willing to accept but I can appreciate that obstacle being tiny for others.
Don't give up hope. Big Brother has mandated that the brokers will have to do the complete TIPS arithmetic for you for purchases after January 1, 2016. :beer

(Of course the date was originally January 1, 2013 but we can still all hope.)
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