TIPS Question

[Prudence]

Let's say I want to buy some TIPS (not a mutual fund) to protect our portfolio against high unexpected inflation but I am not interested in building and maintaining a TIPS ladder. Suppose I buy 10 year TIPS from Treasury Direct this month and plan to hold them to maturity in 2029. Let's assume that there is very high inflation in multiple years before 2029. So, I will be using non TIPS sources (probably cash and fixed accounts) to cover residual expense outlays before 2029. When the TIPS are redeemed in 2029, the principal will have increased due to inflation adjustments. So, am I in the same net position as I would have been had I established a ladder (e.g. for TIPS maturing in 2025, 2026, 2027, 2028 and 2029, if these maturities existed)? (BTW, for this example question I am assuming that any interest rate impacts are neutral).

[Kevin M]

Let's say I want to buy some TIPS (not a mutual fund) to protect our portfolio against high unexpected inflation but I am not interested in building and maintaining a TIPS ladder. Suppose I buy 10 year TIPS from Treasury Direct this month and plan to hold them to maturity in 2029. Let's assume that there is very high inflation in multiple years before 2029. So, I will be using non TIPS sources (probably cash and fixed accounts) to cover residual expense outlays before 2029. When the TIPS are redeemed in 2029, the principal will have increased due to inflation adjustments. So, am I in the same net position as I would have been had I established a ladder (e.g. for TIPS maturing in 2025, 2026, 2027, 2028 and 2029, if these maturities existed)? (BTW, for this example question I am assuming that any interest rate impacts are neutral).

TIPS maturing in those years do exist. The gaps are between 2029 and 2032, and between 2032 and 2040.

Not sure exactly what you're asking, but why would use use non-TIPS fixed income to cover expenses in 2025-2028 instead of your TIPS maturing in those years if you want no inflation risk?

If you don't use the proceeds from the maturing TIPS for residual living expenses, but reinvest them instead, we can't say how that would compare to putting it all into 2029 TIPS, since we don't know the reinvestment rates you'd get in the years your earlier-dated TIPS mature.

Kevin

[Prudence]

Let's say I want to buy some TIPS (not a mutual fund) to protect our portfolio against high unexpected inflation but I am not interested in building and maintaining a TIPS ladder. Suppose I buy 10 year TIPS from Treasury Direct this month and plan to hold them to maturity in 2029. Let's assume that there is very high inflation in multiple years before 2029. So, I will be using non TIPS sources (probably cash and fixed accounts) to cover residual expense outlays before 2029. When the TIPS are redeemed in 2029, the principal will have increased due to inflation adjustments. So, am I in the same net position as I would have been had I established a ladder (e.g. for TIPS maturing in 2025, 2026, 2027, 2028 and 2029, if these maturities existed)? (BTW, for this example question I am assuming that any interest rate impacts are neutral).

TIPS maturing in those years do exist. The gaps are between 2029 and 2032, and between 2032 and 2040.

Not sure exactly what you're asking, but why would use use non-TIPS fixed income to cover expenses in 2025-2028 instead of your TIPS maturing in those years if you want no inflation risk?

If you don't use the proceeds from the maturing TIPS for residual living expenses, but reinvest them instead, we can't say how that would compare to putting it all into 2029 TIPS, since we don't know the reinvestment rates you'd get in the years your earlier-dated TIPS mature.

Kevin

What I meant is that I would not have a TIPS ladder. I would only have a 10 year TIPS maturing in 2029. And I would hold it to maturity.

[KJVanguard]

Could just make life as easy as possible by buying Vanguard's TIPS fund.

[Prudence]

Unfortunately, a TIPS fund can't necessarily protect the principal, so, I am thinking about just buying a ten year TIPS and holding to maturity as an insurance policy against rampant inflation.

[KJVanguard]

A TIPS fund is enough protection for my needs. I used to own that fund back long ago when yields were higher, eventually selling when real yields went negative.

I have owned 10-year TIPSs bought at auction from Vanguard's bond desk in 2000 & 2002. Held them to maturity. They were a good investment.

[Prudence]

Let's say I want to buy some TIPS (not a mutual fund) to protect our portfolio against high unexpected inflation but I am not interested in building and maintaining a TIPS ladder. Suppose I buy 10 year TIPS from Treasury Direct this month and plan to hold them to maturity in 2029. Let's assume that there is very high inflation in multiple years before 2029. So, I will be using non TIPS sources (probably cash and fixed accounts) to cover residual expense outlays before 2029. When the TIPS are redeemed in 2029, the principal will have increased due to inflation adjustments. So, am I in the same net position as I would have been had I established a ladder (e.g. for TIPS maturing in 2025, 2026, 2027, 2028 and 2029, if these maturities existed)? (BTW, for this example question I am assuming that any interest rate impacts are neutral).

Thanks, that helps.

[Raybo]

TIPS pay interest every 6 months. If you only have a single 10-year TIPS, then your interest will be calculated based only on the terms of that security. If you had a ladder of different years, the interest you would be paid would be based on the interest rate of each individual TIPS in the ladder. As such, you wouldn't be in exactly the same position if you had a single 10-year TIPS versus the same amount of money in TIPS ladder.

In addition, if you have a ladder of TIPS, then after each one comes due, you will get a lump sum (the amount of the bond plus inflation adjustments) in each year of the ladder. You will have reinvestment risk with these payouts. That is, when your 2027 TIPS comes due, you need to reinvest those funds. Depending on a number of factors (inflation rate, interest rate, etc) you may or may not be able to reinvest these funds at a higher/same/lower rate than the single 2029 TIPS.

It is my assumption that if inflation spikes up, the real rate that TIPS pay goes down. Put another way, when inflation goes up, the demand for inflation insurance goes up and the rates paid on TIPS should go down.
So, if the event you are worried about happens, your reinvestment of the ladder's proceeds likely would be at an real interest rate below your single TIPS due in 2029. Of course, the opposite could happen, too.

My answer is that there is no way to know if you will be better or worse off if you have a single TIPS or a similar amount in a ladder. It will depend on what happens in the interim.

[Cheyenne]

Unfortunately, a TIPS fund can't necessarily protect the principal....

Please excuse my ignorance but is VIPSX (Vanguard Inflation-Protected Securities Fund) a TIPS fund? And would the principal not be protected if I invested in it? I looked but haven't been able to find the answer myself. Thanks

[Peter G]

Surely (reflecting my hesitancy), the answer is 'no', I wouldn't expect you to be in the same net position owning one maturity date TIPS as owning a ladder during a period of unexpected inflation.
Without the ladder, your cash and fixed accounts (is that nominal bonds?) would give you less purchasing power in the years to 2029, whereas a ladder would better maintain your purchasing power during those years. The coupons from the 2029 TIPS wouldn't give you much through the earlier years, unless you had a LOT of those TIPS.

[Kevin M]

<snip>
Suppose I buy 10 year TIPS from Treasury Direct this month and plan to hold them to maturity in 2029. Let's assume that there is very high inflation in multiple years before 2029. So, I will be using non TIPS sources (probably cash and fixed accounts) to cover residual expense outlays before 2029.
<snip>
So, am I in the same net position as I would have been had I established a ladder (e.g. for TIPS maturing in 2025, 2026, 2027, 2028 and 2029, if these maturities existed)?
<snip>

Not sure exactly what you're asking, but why would use use non-TIPS fixed income to cover expenses in 2025-2028 instead of your TIPS maturing in those years if you want no inflation risk?

What I meant is that I would not have a TIPS ladder. I would only have a 10 year TIPS maturing in 2029. And I would hold it to maturity.

But you were asking if you would be in the same position as if you had bought a ladder.

I've underlined the key points in the quotes above.

No, you probably would not be in the same position, because you would have to have spent more of the money from non-TIPS fixed income in the years prior to 2029, and because your posited high inflation would have eroded the purchasing power of your non-TIPS fixed income during those years. So all other things being equal, your portfolio would be smaller in 2029 with the single TIPS instead of a TIPS ladder.

This assumes that the inflation is unexpected. The non-TIPS fixed income yields typically will have an expected inflation component built into the nominal yield, so if high inflation is expected, the nominal yields typically will be high to compensate for it. Inflation expectations currently are muted, so longer-term nominal yields don't have much of an expected inflation component included.

Also, unless short-term yields are suppressed, as they had been in recent years by the Fed holding the short-term rate at close to 0%, and as they were in the 1940s, short-term yields typically will respond quickly to unexpected inflation, so rolling short-term nominal fixed income is likely to do better in real terms than intermediate-term or long-term nominal fixed income. So if you keep your fixed income short term, and the unexpected inflation doesn't spike too quickly, you may come out about the same as with the TIPS.

Kevin

[Prudence]

Unfortunately, a TIPS fund can't necessarily protect the principal....

Please excuse my ignorance but is VIPSX (Vanguard Inflation-Protected Securities Fund) a TIPS fund? And would the principal not be protected if I invested in it? I looked but haven't been able to find the answer myself. Thanks

I know less about this than anyone else on this thread, but here is a simple answer. If I buy a TIPS and hold it to maturity, I will receive my original or adjusted principal whichever is greater. If I invest in a TIPS fund, the bonds in the fund are going and coming and constantly adjusted to market value. So, when I withdraw funds, the price or value may have decreased since my original investment.

[antiqueman]

If you buy one TIPS, you will only have inflation protection for that ONE bond, not any of your other fixed income.

You are correct that a TIPS mutual fund fluctuates in value. You may have more or less than your initial investment when you sell the TIPS fud.

I have a large TIPS ladder. Bought mostly from yearly auctions that occur in January each year. I buy them in my Schwab 401k account. It takes less than 30 seconds to put the buy order in. Then at some date in the future ( plan to hold to maturity) the TIPS will be redeemed and I will spend the proceeds for part of my living expenses that year.

Literally , it shouldn't take more than 30 seconds each year to buy the TIP for that year. If you plan to hold to maturity there is no need to bother with the TIP again until it matures.

[Prudence]

If you buy one TIPS, you will only have inflation protection for that ONE bond, not any of your other fixed income.

You are correct that a TIPS mutual fund fluctuates in value. You may have more or less than your initial investment when you sell the TIPS fud.

I have a large TIPS ladder. Bought mostly from yearly auctions that occur in January each year. I buy them in my Schwab 401k account. It takes less than 30 seconds to put the buy order in. Then at some date in the future ( plan to hold to maturity) the TIPS will be redeemed and I will spend the proceeds for part of my living expenses that year.

Literally , it shouldn't take more than 30 seconds each year to buy the TIP for that year. If you plan to hold to maturity there is no need to bother with the TIP again until it matures.

In this specific transaction, is the execution better with Schwab than Vanguard?

[Cheyenne]

In this specific transaction, is the execution better with Schwab than Vanguard?

You read my mind. I'd like to know that also.

And another question: Would an investor invest in a TIPS fund rather than a bond fund to minimize the swings in value, and accept lower earnings in exchange?

[antiqueman]

I have only used Schwab.

But it shouldn't be hard anywhere. Simply go to Auctions on the page that list bonds , and select the TIPS auction that will be auctioned. I think the next one will be a 10 year auction week after next. ( It might be 30 years TIPS but I think its a 10). Put in the face value amount you want to purchase and then just wait for the auction to concluded. You should have your bid in by about 10 am the day of the auction. ( I enter my bid the day before)

You will receive the exact same price as the millions of other "noncompetitive bids". It really is simple and in my opinion a great way to provide inflation protection , especially in retirement if you plan to just spend the money.

PS. the terms of the auction have not been announced yet, so you will not find it under the "auction" until probably a week from this coming Monday.

[Kevin M]

In this specific transaction, is the execution better with Schwab than Vanguard?

It doesn't matter if you buy only at auction. Same price/yield at Schwab, Vanguard, and any other broker, unless they charge a fee or commission.

I've noticed slightly lower prices at Schwab for smaller quantities (less than 150) on secondary market than at Fidelity or Vanguard.

Kevin

[Prudence]

<snip>
Suppose I buy 10 year TIPS from Treasury Direct this month and plan to hold them to maturity in 2029. Let's assume that there is very high inflation in multiple years before 2029. So, I will be using non TIPS sources (probably cash and fixed accounts) to cover residual expense outlays before 2029.
<snip>
So, am I in the same net position as I would have been had I established a ladder (e.g. for TIPS maturing in 2025, 2026, 2027, 2028 and 2029, if these maturities existed)?
<snip>

Not sure exactly what you're asking, but why would use use non-TIPS fixed income to cover expenses in 2025-2028 instead of your TIPS maturing in those years if you want no inflation risk?

What I meant is that I would not have a TIPS ladder. I would only have a 10 year TIPS maturing in 2029. And I would hold it to maturity.

But you were asking if you would be in the same position as if you had bought a ladder.

I've underlined the key points in the quotes above.

No, you probably would not be in the same position, because you would have to have spent more of the money from non-TIPS fixed income in the years prior to 2029, and because your posited high inflation would have eroded the purchasing power of your non-TIPS fixed income during those years. So all other things being equal, your portfolio would be smaller in 2029 with the single TIPS instead of a TIPS ladder.

This assumes that the inflation is unexpected. The non-TIPS fixed income yields typically will have an expected inflation component built into the nominal yield, so if high inflation is expected, the nominal yields typically will be high to compensate for it. Inflation expectations currently are muted, so longer-term nominal yields don't have much of an expected inflation component included.

Also, unless short-term yields are suppressed, as they had been in recent years by the Fed holding the short-term rate at close to 0%, and as they were in the 1940s, short-term yields typically will respond quickly to unexpected inflation, so rolling short-term nominal fixed income is likely to do better in real terms than intermediate-term or long-term nominal fixed income. So if you keep your fixed income short term, and the unexpected inflation doesn't spike too quickly, you may come out about the same as with the TIPS.

Kevin

Kevin, see underlined section. Does that statement apply to either my owning a short term bond or a short term bond fund?

[OnTrack]

In this specific transaction, is the execution better with Schwab than Vanguard?

You read my mind. I'd like to know that also.

And another question: Would an investor invest in a TIPS fund rather than a bond fund to minimize the swings in value, and accept lower earnings in exchange?

From my own recent experience, a TIPS fund that I bought has swung in value, mostly down.

[Prudence]

In this specific transaction, is the execution better with Schwab than Vanguard?

You read my mind. I'd like to know that also.

And another question: Would an investor invest in a TIPS fund rather than a bond fund to minimize the swings in value, and accept lower earnings in exchange?

No because a TIPS fund and a bond fund are both subject to fluctuations in value. Most investors that have a TIPS fund also have a bond fund in their fixed allocation. They are willing to accept a lower return on the TIPS fund in return for some protection of their investment from the incurrence of unexpected inflation.

[Cheyenne]

In this specific transaction, is the execution better with Schwab than Vanguard?

You read my mind. I'd like to know that also.

And another question: Would an investor invest in a TIPS fund rather than a bond fund to minimize the swings in value, and accept lower earnings in exchange?

No because a TIPS fund and a bond fund are both subject to fluctuations in value. Most investors that have a TIPS fund also have a bond fund in their fixed allocation. They are willing to accept a lower return on the TIPS fund in return for some protection of their investment from the incurrence of unexpected inflation.

Thanks for answering that.

[dbr]

In this specific transaction, is the execution better with Schwab than Vanguard?

You read my mind. I'd like to know that also.

And another question: Would an investor invest in a TIPS fund rather than a bond fund to minimize the swings in value, and accept lower earnings in exchange?

No because a TIPS fund and a bond fund are both subject to fluctuations in value. Most investors that have a TIPS fund also have a bond fund in their fixed allocation. They are willing to accept a lower return on the TIPS fund in return for some protection of their investment from the incurrence of unexpected inflation.

Thanks for answering that.

Right, it should be kept in mind that all TIPS are adjusted (compensated, immunized if you will) for inflation measured by CPI but must still be sensitive in price to the interest rate. However, for TIPS the applicable interest rate is real rates for that maturity rather than nominal rates as for nominal bonds. If one wants an instrument that is inflation adjusted but fixed in real dollars one can acquire I bonds, which are also tax deferred for thirty years. Puchase limits on I bonds limit their usefulness.

[Prudence]

dbr, regarding ibonds, I see that I can buy up to $10,000 electronic per year plus up to $5,000 paper (total $15,000 limit per year). The estimated tax payment for Q4 is due January 15th. So, I can make another payment now to Treasury in order to ensure my refund for the 2018 tax year is at least $5,000, right?

[dbr]

dbr, regarding ibonds, I see that I can buy up to $10,000 electronic per year plus up to $5,000 paper (total $15,000 limit per year). The estimated tax payment for Q4 is due January 15th. So, I can make another payment now to Treasury in order to ensure my refund for the 2018 tax year is at least $5,000, right?

As far as I know, but I am not an authority on taxes.

[Kevin M]

Also, unless short-term yields are suppressed, as they had been in recent years by the Fed holding the short-term rate at close to 0%, and as they were in the 1940s, short-term yields typically will respond quickly to unexpected inflation, so rolling short-term nominal fixed income is likely to do better in real terms than intermediate-term or long-term nominal fixed income. So if you keep your fixed income short term, and the unexpected inflation doesn't spike too quickly, you may come out about the same as with the TIPS.

Kevin, see underlined section. Does that statement apply to either my owning a short term bond or a short term bond fund?

Sure. Holding something like Vanguard short-term Treasury index fund would be very similar to rolling a 1-3 year ladder of individual Treasuries.,

Given that the TIPS yield curve is flat from 5-year to 10-year maturity at about 0.9% real, and actually inverted at maturities of less than five years (yields are higher than 1%), you don't get any extra real yield with the 10-year TIPS compared to sticking with shorter-term bonds.

SEC yield of the short-term Treasury index fund is about 2.6%. The risk with the shorter-term bonds is that rates decline over the next 10 years, and you end up earning less than 2.6% over the 10-year period.

Kevin

[Prudence]

Kevin, what is the logic driving this? Suppose we are continuing along with about 2.2% inflation per CPI and SEC yield on short term Treasury bond fund of 2.6% and then unexpectedly the inflation trend jumps to 3% annual or greater (due to some heretofore unknown like spike in price of oil, or known like interest on the national debt, labor shortage etc.). We can assume that this new trend will continue until something (like Volker) puts a stop to it. So, why would the yield on short term Treasuries gradually rise to say 3.5% or greater? The reasons may be obvious but I am asking for your opinion because inflation has been under control since 1990 - 1991. Per chance, do you have a line chart comparing historical inflation rate and short term Treasury bond rate?

If yields on short term Treasuries were to decline over the next ten years, that would suggest that expected and unexpected inflation would also would have declined, right?

[Kevin M]

Kevin, what is the logic driving this? Suppose we are continuing along with about 2.2% inflation per CPI and SEC yield on short term Treasury bond fund of 2.6% and then unexpectedly the inflation trend jumps to 3% annual or greater (due to some heretofore unknown like spike in price of oil, or known like interest on the national debt, labor shortage etc.). We can assume that this new trend will continue until something (like Volker) puts a stop to it. So, why would the yield on short term Treasuries gradually rise to say 3.5% or greater? The reasons may be obvious but I am asking for your opinion because inflation has been under control since 1990 - 1991. Per chance, do you have a line chart comparing historical inflation rate and short term Treasury bond rate?

Chart below shows year over year inflation % and 3-month Treasury yield.

If yields on short term Treasuries were to decline over the next ten years, that would suggest that expected and unexpected inflation would also would have declined, right?

Nominal yields tend to respond to expected inflation--only TIPS respond to unexpected inflation (that's their main benefit). But there also are liquidity and unexpected-inflation risk premiums involved, and these can change over time. So nominal yields and real yields can change at different rates. Finally, the government can suppress short-term nominal yields artificially, as we saw in 1940s and early 1950s, and since 2008 until recently (note that 3-month Treasury yield recently catching up with YOY inflation).

With all of these caveats, a decline in short-term Treasury yields would tend to be accompanied by a decline in short-term inflation expectations.

Kevin