TIPS Ladder vs. TIPS Mutual Fund

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esetter
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TIPS Ladder vs. TIPS Mutual Fund

Post by esetter » Tue Nov 18, 2008 8:24 am

As an early retiree (age 63), I been wondering whether it would be advantageous to create and maintain a 10 year ladder of current auction TIPS instead of investing in Vanguard’s TIPS mutual fund (Admiral shares).

By doing this, I would be locking in my real interest rate for each individual investment and would be certain of redeeming each investment at par (I know that the market value will vary during the 10 year period). I haven’t given much thought as to how I would rebalance the ladder to maintain my target asset allocation.

Does anyone have thoughts on the pros and cons of the ladder vs. the mutual fund?

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PiperWarrior
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Post by PiperWarrior » Tue Nov 18, 2008 9:00 am

You might be interested in reading Individual Bonds vs a Bond Fund. Since you seem to be able to get Admiral Shares, which comes with a 0.10% price tag, the cost may not be much of a concern. Control over maturity may be a big item if you are funding a specific purchase or lock in the most attractive yield.

larryswedroe
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Post by larryswedroe » Tue Nov 18, 2008 9:19 am

There are clear advantages to individual bonds. First you save the fee of the fund

But importantly you can take advantage of apparent anomalies--at least now---you can buy for example the 1/2016 bonds yielding much higher than longer and shorter ones. So why own an index fund that owns in effect a ladder? Why not buy the sweet spot?

As long as you are willing to give up the convenience of a fund there is no advantage, except slightly lower trading costs. But you are going to be a buy and hold investor anyway, so that is not really an issue as spreads are fairly tight anyway

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bobcat2
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TIPS vs TIPS bond funds

Post by bobcat2 » Tue Nov 18, 2008 9:25 am

Investing in TIPS, or a TIPS ladder, is much safer than investing in a TIPS bond fund. You're always certain of getting your full principal if you hold an individual TIP bond until maturity. Sell before maturity and you'll get the current price and risk losing principal. On the other hand, there is no maturity date when you buy shares in a TIP bond fund. While the individual bonds that make up the fund have maturity dates, the fund itself does not.

The above means that when you hold TIPS in a mutual fund it becomes just another risky asset, but in order for TIPS to be really safe; to use them to lock in a spending target, you have to be able to match the maturity of the bond to your spending goal. That can't be done with TIPS mutual funds.

Here is one of several recent threads on TIP ladders.
http://www.bogleheads.org/forum/viewtop ... ght=ladder

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

livesoft
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Post by livesoft » Tue Nov 18, 2008 9:33 am

larryswedroe wrote:But importantly you can take advantage of apparent anomalies--at least now---you can buy for example the 1/2016 bonds yielding much higher than longer and shorter ones. So why own an index fund that owns in effect a ladder? Why not buy the sweet spot?
Since the Vanguard inflation protected securities fund is actively-managed, don't you think the managers take advantage of apparent anomalies as well? Don't they buy the sweet spot? Isn't that their job??

dbr
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Re: TIPS vs TIPS bond funds

Post by dbr » Tue Nov 18, 2008 10:06 am

bobcat2 wrote: The above means that when you hold TIPS in a mutual fund it becomes just another risky asset, but in order for TIPS to be really safe; to use them to lock in a spending target, you have to be able to match the maturity of the bond to your spending goal. That can't be done with TIPS mutual funds.

Bob K
Bob, perhaps you can expand on the concept of "lock in a spending target."

Consider a retiree looking forward to supporting thirty or forty years of retirement by withdrawing an inflation adjusted 4% from a portfolio. Assume further the investor is 40:60 stocks:bonds and the bonds are 100% in TIPS. We further assume the investor is at least a decade away from RMD's to start but does have both tax deferred and taxable accounts.

What would be recommended to that investor re a ladder of individual TIPS bonds vs buying a TIPS fund?

As a second example consider an investor more than ten years away from retirement. What kind of spending targets would such an investor "lock in" and if there are none is there still a good reason to prefer individual bonds vice a fund?

I am just trying to visualize the mechanics out over an extended period of time.

Thanks

johnb
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Post by johnb » Tue Nov 18, 2008 10:30 am

How do you buy individual TIPS in your Vanguard retirement account? Thanks for the help!

John

Topic Author
esetter
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Post by esetter » Tue Nov 18, 2008 9:10 pm

Thanks everyone for your comments. I wasn't aware that there had been previous threads on TIPS ladders. And here I thought I had an original thought.

Larry, the transaction costs of buying the sweet spot might be a bit higher than you indicated. Using Vanguard's on-line TIPS prices, it looks like the bid-ask spread can be 20 basis points in yield or more. I don't know (does anyone?) whether you can get a better ask price by calling the bond desk directly.

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