Still time to buy TIPS

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rm
Posts: 274
Joined: Fri Oct 31, 2008 6:09 pm

Still time to buy TIPS

Post by rm »

I was lucky enough to get into VIPSX when it was around 11.0 based on reading this board.

Is the yield difference between VIPSX and US treasury still > 3%. I saw on yahoo finance that VIPSx yield was ~ 5.3%. I don't know if this is a good way to determine the time to buy VIPSX. In any case, I need to increase my bond AA from 8% to 16% and am considering VIPSX vs Vanguard ltd term treasury or Vanguard ltd term tax-exempt (muni). Any thoughts on which one would be the best would be appreciated. I am in the highest tax bracket in CA.

Note: I am not interested in purchasing individual bonds but there may be a correlation between what individual TIPS are selling and whether its a good time for VIPSX.
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robot
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Re: Still time to buy TIPS

Post by robot »

rm wrote:Is the yield difference between VIPSX and US treasury still > 3%. I saw on yahoo finance that VIPSx yield was ~ 5.3%.

The data on finance.yahoo.com seems to be stale. Vanguard's page for VIPSX has the yield at 2.64% as of today.
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Speedy
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Post by Speedy »

Yahoo data is from Morningstar. The following quote from Morningstar describes how the yield is calculated. What isn't clear is that the stated yield from M* appears to be adjusted for inflation, so it is in effect the nominal yield, whereas, Vanguard is reporting real yield without the inflation adjustment. I'm pretty sure this fund (VIPSX) did not have a 5.28% real yield over the last year.
Yield, expressed as a percentage, represents a fund's income return on capital investment for the past 12 months. Morningstar computes yield by dividing the sum of the fund's income distributions (interest distributions from fixed-income securities, dividends from stocks, and realized gains from currency transactions) for the past 12 months by the previous month's NAV (adjusted upward for any capital gains distributed over the same time period).
Conventional wisdom would suggest a California resident in the highest tax bracket should consider one of the Vanguard Muni funds for a taxable account. If the Calif budget were not such a disaster, perhaps a Calif muni fund. The limited term tax exempt seems like a fairly conservative choice for a taxable account and seems to be popular with some on the forum, but would be subject to Calif income tax.

Regards,
Bill
raywax
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real versus nominal yield

Post by raywax »

Speedy said " What isn't clear is that the stated yield from M* appears to be adjusted for inflation, so it is in effect the nominal yield,"

Yet the Finance Buff says "All yields are real yields, after inflation/deflation adjustments." at http://thefinancebuff.com/2008/10/tips- ... ation.html

This is not the first time I have seen nominal yield defined as with the inflation adjustment though I was trained that real yield is with the inflation adjustment.

Can someone provide a definite definition of "real" and "nominal" yield for TIPS with a documentable source?

Ray

PS I found this - The yield quoted for TIPS is the real yield, with inflation already factored in - at http://www.investinginbonds.com/learnmo ... ubcatid=77
maxwellthedog
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Post by maxwellthedog »

The thing to remember is that your return from TIPs comes from two different sources.

1) YTM of the bond on a par basis, and
2) Appreciation of the bond principal (growth in par) by the inflation factor.

When people quote "real" or "nominal" yields, what they are really referring to is the the YTM of the bond as they are quoted-- which is on a par basis, and is therefore a "real" yield-- and the YTM *plus* the accretion of the principal of the bond due to the inflation factor, which is a nominal yield (because it includes return from the inflation factor growth).

For example, imagine you have a one year TIP trading at par which has a 3% coupon. The YTM of this bond is 3% and we can call that a "real yield" because we know that will be our yield after accounting for inflation over the life of the bond no matter what inflation is. Why? Because we know that as inflation is reported, the par value of the bond will increase by the reported level of inflation (the inflation factor). For example, our bond might have an inflation factor of 1.2 when we buy it-- so we have to pay $120 to buy one bond which will return $120 when it matures.

Now imagine that inflation is 5% over the remaining life of the bond. That means that the inflation factor goes from 1.2 to 1.26 when it matures. So you buy your bond at $120, you get your 3% coupon (on a face value of 120), and you get 126 for the principal at maturity. If you add all this up, your total return on the bond is actually the 3% YTM *plus* the 5% accretion of principal-- for a total return of 8%.

Of course, as you earned your 8% total return, inflation eroded the purchasing power of your dollars by 5%, so your "real" return (defined as nominal, or total, return less inflation) is only 3%-- which is what we calculated at the beginning.

At the end of the day, I think it makes the most sense to talk about total returns instead of real and nominal returns. The morningstar definition is actually a total return-- how much you earn divided by how much you invested. That is what is most important. "Real" returns are nice to discuss, but they are not what you will see in your account when you go to calculate your portfolio returns for the year. Real returns are useful for understanding when TIPs are "cheap" and offer value because real yields are relatively stable over time. So a 3% real yield, as was offered a few months ago, is a nice time to buy. We know because of the history of real returns across asset classes over time (and 3% is high).

One other point-- this is a matter of personal opinion, but I actually classify TIPs as real assets (more like real estate, gold, or commodities) rather than bonds. TIPs will behave very differently than US treasury bonds as (nominal UST) rates rise and fall. For example, if we head into an inflationary environment, regular bonds will get crushed while TIPs will keep pace with inflation (like a real asset). So to answer the initial question in this thread about what to buy, munis, UST's, corps, and HY bonds are all good candidates for your bond allocation. TIPs will work, but I think they belong in the real portion of your portfolio...

Like I said, it is personal preference. I know big institutional investors who come out on different sides of this debate.
raywax
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nominal and real yield

Post by raywax »

maxwellthedog wrote:
Like I said, it is personal preference. I know big institutional investors who come out on different sides of this debate.
Yes it may be but it is confusing.

Nevertheless, you response is appreciated.

Ray
maxwellthedog
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Post by maxwellthedog »

One other point-- because a portion of a TIP's return comes from inflation accretion, they are not very tax efficient. You have to pay annual taxes on the amount by which the principal accretes, even if you do not earn actual cash (similar to a bond OID).

So Taxes are a drag on both your "real" and your "nominal" returns on TIPs. Taxes do not affect munis...
Topic Author
rm
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Post by rm »

Thanks maxwellthedog. I understand.

But still don't know where I get the correct date from. As you mentioned 3% is good - basically what we are saying is that 3% over and above inflation in a riskless security is an excellent buy. So what is the "real" rate right now. Is it the yahoo data, vanguard data or somewhere else.
Valuethinker
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Post by Valuethinker »

rm wrote:Thanks maxwellthedog. I understand.

But still don't know where I get the correct date from. As you mentioned 3% is good - basically what we are saying is that 3% over and above inflation in a riskless security is an excellent buy. So what is the "real" rate right now. Is it the yahoo data, vanguard data or somewhere else.
Bloomberg or WSJ can give you a figure for the individual bonds.

If you took the weighted average by the last Vanguard Statement of each bond (where the real yields come off Bloomberg) then you would get pretty close.

I believe it is around 2.1% real. Certain TIPS were trading at much higher real yields, but I believe that has flattened out.

Talking about the coupon for a TIPS is somewhat meaningless. The return from a TIPS is split between the increase in the face value (due to CPI adjustment) and the coupon (also adjusted by CPI).

It's your *real* return that you care about.

Basically the idea with a TIPS fund is that when you need cash, you cash in units.

Note though that US CPI is quite likely to go negative (reducing the face value fo the TIPS) at least for a brief period.
maxwellthedog
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Post by maxwellthedog »

Actually the coupon on a TIP bond is a big driver of the return. Because of the inflation adjustment to the principal (and consequently the coupon multiplied by that principal), most TIPs tend to trade relatively close to par. For any bond close to par, the majority of the YTM you earn is from the coupon income.

In other words, if inflation went to zero over the remaining life of the bond, all of your return would be driven by the coupon income (and whatever pull to par there is from where you bought the bond). Because inflation will likely be higher than zero (though maybe not in the near term) then a TIP will return more than just the stated YTM due to the inflation adjustment).

Like i said earlier, the real yield helps you determine when TIPs are "cheap" relative to history. a 3% real yield on a riskless security is quite attractive. At the end of the day, however, what you get paid is your nominal return, not your real return-- just like with any other asset you own. Nominal return, or "total return", is what puts money in your account to pay for your retirement, or kid's college, or baseball card collection. your real return is your nominal return less the rate of inflation over the period you earned it. for all of your assets.

You can definitely get real yields and breakeven inflation rates off of bloomberg. If the WSJ has quotes on TIPs then the YTM's they quote are also real yields. Finally, the Vanguard SEC yield quoted on their website for the TIPs fund also does not take into account the inflation factor-- so it is a real yield as well (for the entire fund).
Roy
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Getting cheaper...

Post by Roy »

Might be another buying opportunity soon on longer TIPS. 10-year yield (on Bloomberg) is back to almost 2.0. And VIPSX is 11.44, and still dropping along with stocks.

Interesting thing TIPS...

Roy
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cato
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Post by cato »

There are two reasons for nominal treasury rates to increase:

1) Anticipation of an oversupply and resultant inflation.

2) Higher perception of default risk (yes, I mean risk of US Govt default).

If we believe the market is acting rationally, the fact that TIPs and nominal rates are increasing in lockstep suggests that the market is focusing on #2. This is confirmed by the surge in Credit Default Swaps on US Govt. Debt:

http://uk.reuters.com/article/marketsNe ... 8720090218
Citigroup delenda est.
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