Building a TIPs Ladder

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Prudence
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Building a TIPs Ladder

Post by Prudence » Wed Jan 18, 2017 9:39 am

I am 70 and have never owned any tips. I am thinking about having a tips ladder for 2028 through 2043, with a $15,000 bond to mature each year. I don't know how to do this. I would rather buy only original issue tips and would rather not use a tips mutual fund. Would it make any sense for me to buy a 10 year tips bond every year? This might be beneficial if we had a rapid increase in inflation over a few years which is probably not that likely, otherwise, it does not seem to be very necessary. Any thoughts would be appreciated.

dbr
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Re: Building a TIPs Ladder

Post by dbr » Wed Jan 18, 2017 9:48 am

Prudence wrote:I am 70 and have never owned any tips. I am thinking about having a tips ladder for 2028 through 2043, with a $15,000 bond to mature each year. I don't know how to do this. I would rather buy only original issue tips and would rather not use a tips mutual fund. Would it make any sense for me to buy a 10 year tips bond every year? This might be beneficial if we had a rapid increase in inflation over a few years which is probably not that likely, otherwise, it does not seem to be very necessary. Any thoughts would be appreciated.
There are a couple of people here who may step up with an actual plan for you, but in general if you have the money now, you would want to invest in a $15,000 bond to reach each of those years. That would be a bond maturing in 12 years for 2028, 13 years for 2029, etc to 27 years for 2043. The trick is to find TIPS issues that actually have those maturation dates. You would not use a TIPS fund because a TIPS fund never matures.

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Raybo
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Re: Building a TIPs Ladder

Post by Raybo » Wed Jan 18, 2017 10:09 am

A board member created a google spreadsheet to do the calculations for creating a tip ladder. Try this link: http://eyebonds.info/downloads/pages/TIPSLadder.html
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Aptenodytes
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Re: Building a TIPs Ladder

Post by Aptenodytes » Wed Jan 18, 2017 11:07 am

I believe the most common approach to building a TIPS ladder around here is to do so in one fell swoop, as dbr explains and as the spreadsheet Raybo links to describes. When you build the ladder that way, you have no choice but to buy TIPS in the secondary market.

If you want to limit yourself to original issue TIPS, then you can still build a ladder but it will be constructed gradually and it will have some irregular gaps in the rungs for a while. I personally don't see anything wrong with this gradual approach for the average person.

If you wanted to limit yourself to original issue TIPS, you could do the following as a very simple approach

2017: sit tight
2018-2033: buy a 10-year TIPS ($15k) each year
2034 onward: sit tight

What that approach lacks, as compared to the build-it-all-at-once ladder, is protection against unexpected inflation for the entire $225K (15 years * $15K) in the early years. You don't get to full protection until 2033.

So a slightly more complicated approach that still uses only original issues would be something like this:

as above, buy $15K individual new-issue TIPS each year 2018-2033
But inflation-protect as much of the total during the initial years by socking it in a single 5-year TIPS, after setting aside what you will need to purchase the coming five years of 10-year TIPS.

So the sequence might start like this:
2017: buy a 5-year TIPS at $165K
2018: buy 10-year TIPS $15K
2019: buy 10-year TIPS $15K
2020: buy 10-year TIPS $15K
2021: buy 10-year TIPS $15K
2022: 5-year TIPS matures. Set aside some for coming 10-year purchases, and buy a new 5-year TIPS at $90K. Also buy 10-year TIPS $15K
2023: buy 10-year TIPS $15K
etc.

You still aren't protecting all the $225K but you are protecting a big majority of it from day 1.

There may be better ways to do this approximation -- But you can see it is more complicated. You need to take into account your interest in and ability to monitor and execute this thing every year.

If you built the ladder all at once, using the secondary market, then you'd have to learn how to do something you'd currently rather not and might find a little uncomfortable, but the huge advantage you would gain for that is that you never have to touch it. The cash just starts getting deposited in your account in 2028.

Prudence
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Re: Building a TIPs Ladder

Post by Prudence » Wed Jan 18, 2017 11:31 am

Aptenodytes wrote:I believe the most common approach to building a TIPS ladder around here is to do so in one fell swoop, as dbr explains and as the spreadsheet Raybo links to describes. When you build the ladder that way, you have no choice but to buy TIPS in the secondary market.

If you want to limit yourself to original issue TIPS, then you can still build a ladder but it will be constructed gradually and it will have some irregular gaps in the rungs for a while. I personally don't see anything wrong with this gradual approach for the average person.

If you wanted to limit yourself to original issue TIPS, you could do the following as a very simple approach

2017: sit tight
2018-2033: buy a 10-year TIPS ($15k) each year
2034 onward: sit tight

What that approach lacks, as compared to the build-it-all-at-once ladder, is protection against unexpected inflation for the entire $225K (15 years * $15K) in the early years. You don't get to full protection until 2033.

So a slightly more complicated approach that still uses only original issues would be something like this:

as above, buy $15K individual new-issue TIPS each year 2018-2033
But inflation-protect as much of the total during the initial years by socking it in a single 5-year TIPS, after setting aside what you will need to purchase the coming five years of 10-year TIPS.

So the sequence might start like this:
2017: buy a 5-year TIPS at $165K
2018: buy 10-year TIPS $15K
2019: buy 10-year TIPS $15K
2020: buy 10-year TIPS $15K
2021: buy 10-year TIPS $15K
2022: 5-year TIPS matures. Set aside some for coming 10-year purchases, and buy a new 5-year TIPS at $90K. Also buy 10-year TIPS $15K
2023: buy 10-year TIPS $15K
etc.

You still aren't protecting all the $225K but you are protecting a big majority of it from day 1.

There may be better ways to do this approximation -- But you can see it is more complicated. You need to take into account your interest in and ability to monitor and execute this thing every year.

If you built the ladder all at once, using the secondary market, then you'd have to learn how to do something you'd currently rather not and might find a little uncomfortable, but the huge advantage you would gain for that is that you never have to touch it. The cash just starts getting deposited in your account in 2028.
Interesting, thanks for all the replies. I am concerned that I may be at a price disadvantage in the secondary market (reason why I prefer new issues), but, do you think the stronger inflation protection by building the ladder all at once using secondary market more than offsets that concern?

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Re: Building a TIPs Ladder

Post by Gill » Wed Jan 18, 2017 1:05 pm

I've built a 10-year TIPS ladder over a period of ten years simply by buying at auction every January. I actually front end loaded it a bit by buying a larger quantity in the earlier years. You could do it this way which, of course, involves no commissions on the purchase.
Gill

Prudence
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Re: Building a TIPs Ladder

Post by Prudence » Wed Jan 18, 2017 1:39 pm

Gill wrote:I've built a 10-year TIPS ladder over a period of ten years simply by buying at auction every January. I actually front end loaded it a bit by buying a larger quantity in the earlier years. You could do it this way which, of course, involves no commissions on the purchase.
Gill
Yes, I have been thinking of doing this. But, it seems that this would leave significant inflation risk beyond a ten year horizon e.g. the risk that $15,000 of 2017 dollars would be of little or no value in 25 years.

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Peter Foley
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Re: Building a TIPs Ladder

Post by Peter Foley » Wed Jan 18, 2017 11:17 pm

Just a question that I hope is not too off topic. Do you build the TIPS ladder in a taxable account or a tax deferred account?

dbr
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Re: Building a TIPs Ladder

Post by dbr » Thu Jan 19, 2017 10:03 am

Peter Foley wrote:Just a question that I hope is not too off topic. Do you build the TIPS ladder in a taxable account or a tax deferred account?
The tax problem with a ladder of individual bonds is that the inflation increment is taxable in each year, as well as the interest payment. Placing everything in a tax deferred account means you won't have to come up with that tax payment every year. This does not overlook that a TIPS fund also has the same tax burden as well as the investor needing to understand that a fund pays out the inflation increment which must then be reinvested to maintain the inflation growth of the investment.

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Prokofiev
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Re: Building a TIPs Ladder

Post by Prokofiev » Thu Jan 19, 2017 10:24 am

"Interesting, thanks for all the replies. I am concerned that I may be at a price disadvantage in the secondary market (reason why I prefer new issues), but, do you think the stronger inflation protection by building the ladder all at once using secondary market more than offsets that concern?"

Yes, buying on the secondary market costs a little more, but it's not a big deal. Vanguard will sell you them for $0 commission (not sure if that is Flagship only) and a typical spread of .2 to .25%. Since you will be buying only and never selling you can cut that in half. Over 10-20 years that amounts to .005%-.02% when seen as a yearly ER. Far below any mutual fund.
Everything should be made as simple as possible, but not simpler - Einstein

Prudence
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Re: Building a TIPs Ladder

Post by Prudence » Thu Jan 19, 2017 10:29 am

Aptenodytes wrote:I believe the most common approach to building a TIPS ladder around here is to do so in one fell swoop, as dbr explains and as the spreadsheet Raybo links to describes. When you build the ladder that way, you have no choice but to buy TIPS in the secondary market.

If you want to limit yourself to original issue TIPS, then you can still build a ladder but it will be constructed gradually and it will have some irregular gaps in the rungs for a while. I personally don't see anything wrong with this gradual approach for the average person.

If you wanted to limit yourself to original issue TIPS, you could do the following as a very simple approach

2017: sit tight
2018-2033: buy a 10-year TIPS ($15k) each year
2034 onward: sit tight

What that approach lacks, as compared to the build-it-all-at-once ladder, is protection against unexpected inflation for the entire $225K (15 years * $15K) in the early years. You don't get to full protection until 2033.

So a slightly more complicated approach that still uses only original issues would be something like this:

as above, buy $15K individual new-issue TIPS each year 2018-2033
But inflation-protect as much of the total during the initial years by socking it in a single 5-year TIPS, after setting aside what you will need to purchase the coming five years of 10-year TIPS.

So the sequence might start like this:
2017: buy a 5-year TIPS at $165K
2018: buy 10-year TIPS $15K
2019: buy 10-year TIPS $15K
2020: buy 10-year TIPS $15K
2021: buy 10-year TIPS $15K
2022: 5-year TIPS matures. Set aside some for coming 10-year purchases, and buy a new 5-year TIPS at $90K. Also buy 10-year TIPS $15K
2023: buy 10-year TIPS $15K
etc.

You still aren't protecting all the $225K but you are protecting a big majority of it from day 1.

There may be better ways to do this approximation -- But you can see it is more complicated. You need to take into account your interest in and ability to monitor and execute this thing every year.

If you built the ladder all at once, using the secondary market, then you'd have to learn how to do something you'd currently rather not and might find a little uncomfortable, but the huge advantage you would gain for that is that you never have to touch it. The cash just starts getting deposited in your account in 2028.
Yesterday, I visited the VG site and viewed the secondary market tips. For example, the tips maturing in 2028 were priced around 112 to 113 and yielding to maturity.5 to .6%. If I buy one of these priced at 113 now, and assuming no changes at all in market interest rates and conditions going forward, and no inflation or deflation at all going forward, that I would receive all of my principal in 2028? OTOH, if there is positive inflation, I would get my principal plus the inflation adjustment?

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#Cruncher
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Re: Building a TIPs Ladder

Post by #Cruncher » Thu Jan 19, 2017 11:47 am

Prudence in original post wrote:I am thinking about having a tips ladder for 2028 through 2043, with a $15,000 bond to mature each year. ... I would rather buy only original issue tips and would rather not use a tips mutual fund.
If you only bought at auction, Prudence, you couldn't complete your ladder until 2033. [1] To build it quicker, you could use a combination of TIPS bought in the secondary market and TIPS bought at auction with a temporary investment in a TIPS fund.
  • This year buy seven TIPS maturing in 2028, 2029, 2032, and 2040-2043 in the secondary market.
  • Invest the balance of your ladder budget in a TIPS fund to cover the nine years in which no TIPS currently mature [2].
  • In 2020, 2021, and 2023-2029 sell some of the TIPS fund and use the proceeds to buy a 10-year TIPS at auction.
Prudence in previous post wrote:... the tips maturing in 2028 were priced around 112 to 113 ... If I buy one of these priced at 113 now, and assuming ... no inflation or deflation at all going forward, that I would receive all of my principal in 2028? OTOH, if there is positive inflation, I would get my principal plus the inflation adjustment?
Judging by the price, Prudence, you're referring to the 1.75% TIPS maturing 1/15/2028. (There is also a TIPS maturing 4/15/2028, but according to the 1/18/2017 WSJ TIPS Quotes its asking price is 133.)

Its index ratio today is 1.15282. (See this web page.) Therefore to buy approximately $15,000 of principal you'd need to buy $13,000 face value (15000 / 1.15282). At maturity you'd receive $13,000 multiplied by the index ratio at that time. For example, if the CPI grew at 2% per year over the eleven remaining years, the index ratio at maturity would be 1.15282 X 1.02 ^ 11 or about 1.43. Therefore, you'd receive $13,000 X 1.43 or $18,600. At a price of 113% the cost of your $13,000 face value purchase would be about $16,900. (13000 X 1.15282 X 113%).
  1. This assumes the Treasury continues to only issue 5, 10, and 30 year TIPS.
  2. You can see the TIPS currently outstanding on the WSJ TIPS Quotes page.

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Peter Foley
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Re: Building a TIPs Ladder

Post by Peter Foley » Thu Jan 19, 2017 11:55 am

Thanks dbr. Where I was headed with this is that building a TIPS ladder in tax deferred, especially if those are the preponderance of one's tax deferred assets, might end up creating a problem with cash available for RMD's. The original proposal was for a ladder from 2028 through 2043 for a person who is currently 70 years old. RMD's start to get steep in one's mid 80's.

The more modest proposal of a 10 year TIPS ladder makes more sense to me. The TIPS mutual funds I have held for years in deferred accounts have not done particularly well.

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FIREchief
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Re: Building a TIPs Ladder

Post by FIREchief » Thu Jan 19, 2017 4:22 pm

Aptenodytes wrote:
So the sequence might start like this:
2017: buy a 5-year TIPS at $165K
2018: buy 10-year TIPS $15K
2019: buy 10-year TIPS $15K
2020: buy 10-year TIPS $15K
2021: buy 10-year TIPS $15K
2022: 5-year TIPS matures. Set aside some for coming 10-year purchases, and buy a new 5-year TIPS at $90K. Also buy 10-year TIPS $15K
2023: buy 10-year TIPS $15K
etc.
As a slight variation, the OP may wish to consider something like this:

2017: sit tight
2018: buy 10-year TIPS $30K, buy 5-year TIPS $15K
2019: buy 10-year TIPS $30K, buy 5-year TIPS $15K
2020: buy 10-year TIPS $30K, buy 5-year TIPS $15K
2021: buy 10-year TIPS $30K, buy 5-year TIPS $15K
2022: buy 10-year TIPS $30K, buy 5-year TIPS $15K
2023: 5 year TIPS $15K matures in April, reinvest in 10 year May reopening
2024: 5 year TIPS $15K matures in April, reinvest in 10 year May reopening
2025: 5 year TIPS $15K matures in April, reinvest in 10 year May reopening
2026: 5 year TIPS $15K matures in April, reinvest in 10 year May reopening
2027: 5 year TIPS $15K matures in April, reinvest in 10 year May reopening
2028: 10 year TIPS $30K matures, keep $15K and reinvest in new 10 year TIPS $15K
2029: 10 year TIPS $30K matures, keep $15K and reinvest in new 10 year TIPS $15K
2030: 10 year TIPS $30K matures, keep $15K and reinvest in new 10 year TIPS $15K
2031: 10 year TIPS $30K matures, keep $15K and reinvest in new 10 year TIPS $15K
2032: 10 year TIPS $30K matures, keep $15K and reinvest in new 10 year TIPS $15K
2033 - 2042: 10 year TIPS $15K matures

This would avoid dropping a huge chunk of cash into 5 year TIPS at a single point in time and would get all the money fully invested in TIPS over a five year period. If desired, the entire $225K could be invested into a TIPS mutual fund immediately as a holding place for the 2018 - 2022 ladder building.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

Prudence
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Re: Building a TIPs Ladder

Post by Prudence » Thu Jan 19, 2017 5:43 pm

#Cruncher wrote:
Prudence in original post wrote:I am thinking about having a tips ladder for 2028 through 2043, with a $15,000 bond to mature each year. ... I would rather buy only original issue tips and would rather not use a tips mutual fund.
If you only bought at auction, Prudence, you couldn't complete your ladder until 2033. [1] To build it quicker, you could use a combination of TIPS bought in the secondary market and TIPS bought at auction with a temporary investment in a TIPS fund.
  • This year buy seven TIPS maturing in 2028, 2029, 2032, and 2040-2043 in the secondary market.
  • Invest the balance of your ladder budget in a TIPS fund to cover the nine years in which no TIPS currently mature [2].
  • In 2020, 2021, and 2023-2029 sell some of the TIPS fund and use the proceeds to buy a 10-year TIPS at auction.
Prudence in previous post wrote:... the tips maturing in 2028 were priced around 112 to 113 ... If I buy one of these priced at 113 now, and assuming ... no inflation or deflation at all going forward, that I would receive all of my principal in 2028? OTOH, if there is positive inflation, I would get my principal plus the inflation adjustment?
Judging by the price, Prudence, you're referring to the 1.75% TIPS maturing 1/15/2028. (There is also a TIPS maturing 4/15/2028, but according to the 1/18/2017 WSJ TIPS Quotes its asking price is 133.)

Its index ratio today is 1.15282. (See this web page.) Therefore to buy approximately $15,000 of principal you'd need to buy $13,000 face value (15000 / 1.15282). At maturity you'd receive $13,000 multiplied by the index ratio at that time. For example, if the CPI grew at 2% per year over the eleven remaining years, the index ratio at maturity would be 1.15282 X 1.02 ^ 11 or about 1.43. Therefore, you'd receive $13,000 X 1.43 or $18,600. At a price of 113% the cost of your $13,000 face value purchase would be about $16,900. (13000 X 1.15282 X 113%).
  1. This assumes the Treasury continues to only issue 5, 10, and 30 year TIPS.
  2. You can see the TIPS currently outstanding on the WSJ TIPS Quotes page.
So, in your above example of the tip maturing in January 2028, I would need to buy thirteen $1,000 bonds (if available) at the market today so I can get inflation protection for $15,000 in my portfolio (to cover my residual expenses in 2028).

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