TIPS

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eastcoastbogle
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TIPS

Post by eastcoastbogle »

If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.

I’m sure I’m going to receive a lot of heat from people for market timing, but that question is more focused on where to store a short term cash chunk that I am holding off on investing pending the impending bear market everyone is “predicting” in the next 12-18 months.
chrisdds98
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Location: Austin, TX

Re: TIPS

Post by chrisdds98 »

There is interest rate risk associated with TIPS. I don't know of a TIPS fund with shorter duration than VTIP which is about 3 years. I-bonds might be a better option for you
Robot Monster
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Re: TIPS

Post by Robot Monster »

chrisdds98 wrote: Thu Jun 17, 2021 5:12 pm There is interest rate risk associated with TIPS. I don't know of a TIPS fund with shorter duration than VTIP which is about 3 years. I-bonds might be a better option for you
Indeed. If someone's investment horizon is 12-18 months, one should match this with the average duration of one's bond holdings in order to minimize interest rate risk. VTIP has an average duration of 2.7 years, so there is a bit of a mismatch with the investment horizon.

The Vanguard Ultra-Short Bond ETF (VUSB) has an average duration of one year, and is therefore more suitable. As the horizon gets smaller, however, you need to begin to transfer money into an instrument with an even shorter duration, like your settlement fund, so that the weighted-average duration between the funds stays matched to the diminishing time horizon. For example, if you split your money equally between the settlement fund and the ultra-short bond fund, your duration would be six months.

(Actually, not quite sure about that. The duration of a money market fund might be a bit more than that.)
"Picking an AA and sticking with it will get you much better off than any strategy that relies on pontificating on the market." -- our favorite golfer
powercherry5
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Re: TIPS

Post by powercherry5 »

What is the "interest rate risk"?
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nisiprius
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Re: TIPS

Post by nisiprius »

powercherry5 wrote: Thu Jun 17, 2021 7:01 pm What is the "interest rate risk"?
It is a fluctuation in the market value of a bond. It occurs if you want to buy or sell a bond at some time in between issue and maturity. Since a bond fund holds many bonds with different issue and maturity dates, it is always expose to interest rate risk.

Suppose you have paid $1,000 to buy a ten-year bond that pays 1% per year in interest. Five years after you buy it, you decide that you don't want to hold it to maturity, you want to sell it now. At the time when you sell it, you are competing against newly-issued five-year bonds. If the interest rate has risen, to 2% say, a person who buys a newly issued bond is going to receive bigger coupon payments than they will from your bond. So they will not be willing to pay $1,000 for your bond. They will only buy your bond if you are willing to sell it at a lower, discounted price. That price is almost perfectly determined by "bond math," but it depends on the interest rate available at the time you want to sell your bond. Bond math says that if the interest rate has not changed, your bond is worth $1,000. But if the interest rate has risen, you are competing against better bonds, so your bond is worth less than $1,000. If the interest rate has fallen, your bond is better than the competition, and you can get more than $1,000 for it.

This fluctuation in the value of bonds and bond funds, due to changes in the interest rate, is "interest rate risk."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
NiceUnparticularMan
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Re: TIPS

Post by NiceUnparticularMan »

powercherry5 wrote: Thu Jun 17, 2021 7:01 pm What is the "interest rate risk"?
It depends why interest rates go up. If it is just increased inflation expectations, TIPS should track up. If it is a steepening of the yield curve, TIPS can lose value.
exigent
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Re: TIPS

Post by exigent »

eastcoastbogle wrote: Thu Jun 17, 2021 5:00 pm If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.
This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
chrisdds98
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Location: Austin, TX

Re: TIPS

Post by chrisdds98 »

exigent wrote: Thu Jun 17, 2021 7:55 pm
eastcoastbogle wrote: Thu Jun 17, 2021 5:00 pm If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.
This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
is that an issue for an ETF like VTIP or SCHP in a taxable account?
exigent
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Re: TIPS

Post by exigent »

chrisdds98 wrote: Thu Jun 17, 2021 8:08 pm
exigent wrote: Thu Jun 17, 2021 7:55 pm
eastcoastbogle wrote: Thu Jun 17, 2021 5:00 pm If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.
This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
is that an issue for an ETF like VTIP or SCHP in a taxable account?
Yes and no (as I understand it). See this link, near bottom of second page, “phantom income.” The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta is good?
exigent
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Re: TIPS

Post by exigent »

chrisdds98 wrote: Thu Jun 17, 2021 8:08 pm
exigent wrote: Thu Jun 17, 2021 7:55 pm
eastcoastbogle wrote: Thu Jun 17, 2021 5:00 pm If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.
This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
is that an issue for an ETF like VTIP or SCHP in a taxable account?
Yes and no (as I understand it). Look near bottom of the second page of this linked document, under “phantom income.”

https://www.ishares.com/us/literature/b ... -en-us.pdf

The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta good?
Robot Monster
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Re: TIPS

Post by Robot Monster »

NiceUnparticularMan wrote: Thu Jun 17, 2021 7:49 pm
powercherry5 wrote: Thu Jun 17, 2021 7:01 pm What is the "interest rate risk"?
It depends why interest rates go up. If it is just increased inflation expectations, TIPS should track up. If it is a steepening of the yield curve, TIPS can lose value.
Yes, so to illustrate your point. (And I hope I got this right!)

Let's say Karen buys $1000 of individual 30yr TIPS in a non-taxable account with a yield of 0%. (At the moment it's actually -0.17%, but let's simplify it.) If Karen holds the TIPS to maturity, her money will exactly match whatever inflation was for that 30 year period.

Let's say, however, that over the course of the year after Karen purchased her TIPS, the yield on the 30yr goes up to 1%. (This yield represents the amount investors demand over inflation.) If that were to happen, Karen's TIPS would lose a lot of value. (Errr...about 30%?) The value, however, would, over the next 29 years keep going up, so that at year 30, they would be fully recovered.

So, if you have individual TIPS, the trick is to hold them to maturity. And if you have a TIPS fund, the trick there is similar, to match one's investment horizon with the average duration of the funds you hold. (You can control the duration by owning two TIPS funds and rebalancing accordingly.) If someone wants more details on the mechanics of this, please ask.

And...I hope that was all correct. Please someone correct me if it wasn't.
"Picking an AA and sticking with it will get you much better off than any strategy that relies on pontificating on the market." -- our favorite golfer
chrisdds98
Posts: 203
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Location: Austin, TX

Re: TIPS

Post by chrisdds98 »

exigent wrote: Thu Jun 17, 2021 8:32 pm
chrisdds98 wrote: Thu Jun 17, 2021 8:08 pm
exigent wrote: Thu Jun 17, 2021 7:55 pm
eastcoastbogle wrote: Thu Jun 17, 2021 5:00 pm If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.
This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
is that an issue for an ETF like VTIP or SCHP in a taxable account?
Yes and no (as I understand it). Look near bottom of the second page of this linked document, under “phantom income.”

https://www.ishares.com/us/literature/b ... -en-us.pdf

The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta good?
interesting, thanks for the link. This is a pretty significant advantage over holding individual TIPS, right?
Robot Monster
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Joined: Sun May 05, 2019 11:23 am

Re: TIPS

Post by Robot Monster »

chrisdds98 wrote: Thu Jun 17, 2021 9:06 pm
exigent wrote: Thu Jun 17, 2021 8:32 pm
chrisdds98 wrote: Thu Jun 17, 2021 8:08 pm
exigent wrote: Thu Jun 17, 2021 7:55 pm
eastcoastbogle wrote: Thu Jun 17, 2021 5:00 pm If TIPS are meant to hold with inflation, why would it not be smart to hold cash in a TIPS Index/ETF, in a taxable account? Especially if I’m not currently in a high tax bracket.
This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
is that an issue for an ETF like VTIP or SCHP in a taxable account?
Yes and no (as I understand it). Look near bottom of the second page of this linked document, under “phantom income.”

https://www.ishares.com/us/literature/b ... -en-us.pdf

The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta good?
interesting, thanks for the link. This is a pretty significant advantage over holding individual TIPS, right?
I can confirm I have read that trait as being one of the desirable ones over holding individual TIPS. Personally, I own both funds and individual TIPS. Vanguard, annoyingly, doesn't offer a long-term TIPS fund, and LTPZ has got a high expense ratio compared to Vanguard.
"Picking an AA and sticking with it will get you much better off than any strategy that relies on pontificating on the market." -- our favorite golfer
dcabler
Posts: 1936
Joined: Wed Feb 19, 2014 11:30 am

Re: TIPS

Post by dcabler »

Robot Monster wrote: Thu Jun 17, 2021 9:13 pm
chrisdds98 wrote: Thu Jun 17, 2021 9:06 pm
exigent wrote: Thu Jun 17, 2021 8:32 pm
chrisdds98 wrote: Thu Jun 17, 2021 8:08 pm
exigent wrote: Thu Jun 17, 2021 7:55 pm

This will obviously depend on the details, but… Both the interest on TIPS *and* principal increases are taxable in the year in which they occur. In other words, growth is *not* tax deferred. As such, most avoid holding TIPS in taxable.

Details: https://www.treasurydirect.gov/indiv/re ... ps_tax.htm
is that an issue for an ETF like VTIP or SCHP in a taxable account?
Yes and no (as I understand it). Look near bottom of the second page of this linked document, under “phantom income.”

https://www.ishares.com/us/literature/b ... -en-us.pdf

The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta good?
interesting, thanks for the link. This is a pretty significant advantage over holding individual TIPS, right?
I can confirm I have read that trait as being one of the desirable ones over holding individual TIPS. Personally, I own both funds and individual TIPS. Vanguard, annoyingly, doesn't offer a long-term TIPS fund, and LTPZ has got a high expense ratio compared to Vanguard.
LTPZ is the only game in town for most investors who want a long term TIPs fund. And while that e/r is higher than most index funds at Vanguard, I wouldn't exactly call it high at 0.20%

That said, I'm actually surprised that other providers haven't jumped in to offer some competition. Perhaps with all of the recent inflation talk, that'll change.

Cheers.
hudson
Posts: 4161
Joined: Fri Apr 06, 2007 9:15 am

Re: TIPS

Post by hudson »

dcabler wrote: Fri Jun 18, 2021 6:33 am LTPZ is the only game in town for most investors who want a long term TIPs fund. And while that e/r is higher than most index funds at Vanguard, I wouldn't exactly call it high at 0.20%

Cheers.
VAIPX...TIPS fund...7.2 years, ER= .1% or $1000 on $1 million per year
LTPZ....TIPS ETF ...21.3 years, ER = .2% or $2000 on $1 million per year
Individual TIPS....ER = 0 or $0 per year
MishkaWorries
Posts: 1069
Joined: Wed Aug 14, 2019 4:39 pm

Re: TIPS

Post by MishkaWorries »

dcabler wrote: Fri Jun 18, 2021 6:33 am
Robot Monster wrote: Thu Jun 17, 2021 9:13 pm
chrisdds98 wrote: Thu Jun 17, 2021 9:06 pm
exigent wrote: Thu Jun 17, 2021 8:32 pm
chrisdds98 wrote: Thu Jun 17, 2021 8:08 pm

is that an issue for an ETF like VTIP or SCHP in a taxable account?
Yes and no (as I understand it). Look near bottom of the second page of this linked document, under “phantom income.”

https://www.ishares.com/us/literature/b ... -en-us.pdf

The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta good?
interesting, thanks for the link. This is a pretty significant advantage over holding individual TIPS, right?
I can confirm I have read that trait as being one of the desirable ones over holding individual TIPS. Personally, I own both funds and individual TIPS. Vanguard, annoyingly, doesn't offer a long-term TIPS fund, and LTPZ has got a high expense ratio compared to Vanguard.
LTPZ is the only game in town for most investors who want a long term TIPs fund. And while that e/r is higher than most index funds at Vanguard, I wouldn't exactly call it high at 0.20%

That said, I'm actually surprised that other providers haven't jumped in to offer some competition. Perhaps with all of the recent inflation talk, that'll change.

Cheers.
That 0.2% has to be some easy money. Once a year they buy the new bond and then what? What do they do all day?
We plan. G-d laughs.
NiceUnparticularMan
Posts: 2525
Joined: Sat Mar 11, 2017 7:51 am

Re: TIPS

Post by NiceUnparticularMan »

Robot Monster wrote: Thu Jun 17, 2021 8:50 pm
NiceUnparticularMan wrote: Thu Jun 17, 2021 7:49 pm
powercherry5 wrote: Thu Jun 17, 2021 7:01 pm What is the "interest rate risk"?
It depends why interest rates go up. If it is just increased inflation expectations, TIPS should track up. If it is a steepening of the yield curve, TIPS can lose value.
Yes, so to illustrate your point. (And I hope I got this right!)

Let's say Karen buys $1000 of individual 30yr TIPS in a non-taxable account with a yield of 0%. (At the moment it's actually -0.17%, but let's simplify it.) If Karen holds the TIPS to maturity, her money will exactly match whatever inflation was for that 30 year period.

Let's say, however, that over the course of the year after Karen purchased her TIPS, the yield on the 30yr goes up to 1%. (This yield represents the amount investors demand over inflation.) If that were to happen, Karen's TIPS would lose a lot of value. (Errr...about 30%?) The value, however, would, over the next 29 years keep going up, so that at year 30, they would be fully recovered.

So, if you have individual TIPS, the trick is to hold them to maturity. And if you have a TIPS fund, the trick there is similar, to match one's investment horizon with the average duration of the funds you hold. (You can control the duration by owning two TIPS funds and rebalancing accordingly.) If someone wants more details on the mechanics of this, please ask.

And...I hope that was all correct. Please someone correct me if it wasn't.
Right, if you hold TIPS to maturity you get whatever you were originally expecting real--0% in this case.

But I was also pointing out that suppose nominal rates go up 1% because expected inflation goes up 1%. Nominal bonds will drop in value, but TIPS should not, because investors will expect the nominal rate on TIPS to go up the same 1%.

So, in other words, TIPS will lose value if expected real rates go up, but should not lose value if nominal rates go up but not expected real rates, and nominal bonds will lose value either way if rates go up.
dcabler
Posts: 1936
Joined: Wed Feb 19, 2014 11:30 am

Re: TIPS

Post by dcabler »

MishkaWorries wrote: Fri Jun 18, 2021 6:58 am
dcabler wrote: Fri Jun 18, 2021 6:33 am
Robot Monster wrote: Thu Jun 17, 2021 9:13 pm
chrisdds98 wrote: Thu Jun 17, 2021 9:06 pm
exigent wrote: Thu Jun 17, 2021 8:32 pm

Yes and no (as I understand it). Look near bottom of the second page of this linked document, under “phantom income.”

https://www.ishares.com/us/literature/b ... -en-us.pdf

The funds actually pay this adjustment out so, while it’s taxable in the year in which it occurs (which is bad), at least the dollars are made available to you to handle the taxes — which is kinda, sorta good?
interesting, thanks for the link. This is a pretty significant advantage over holding individual TIPS, right?
I can confirm I have read that trait as being one of the desirable ones over holding individual TIPS. Personally, I own both funds and individual TIPS. Vanguard, annoyingly, doesn't offer a long-term TIPS fund, and LTPZ has got a high expense ratio compared to Vanguard.
LTPZ is the only game in town for most investors who want a long term TIPs fund. And while that e/r is higher than most index funds at Vanguard, I wouldn't exactly call it high at 0.20%

That said, I'm actually surprised that other providers haven't jumped in to offer some competition. Perhaps with all of the recent inflation talk, that'll change.

Cheers.
That 0.2% has to be some easy money. Once a year they buy the new bond and then what? What do they do all day?
Nothing. Robots do it. :-D
MishkaWorries
Posts: 1069
Joined: Wed Aug 14, 2019 4:39 pm

Re: TIPS

Post by MishkaWorries »

dcabler wrote: Fri Jun 18, 2021 2:28 pm
MishkaWorries wrote: Fri Jun 18, 2021 6:58 am
dcabler wrote: Fri Jun 18, 2021 6:33 am
Robot Monster wrote: Thu Jun 17, 2021 9:13 pm
chrisdds98 wrote: Thu Jun 17, 2021 9:06 pm

interesting, thanks for the link. This is a pretty significant advantage over holding individual TIPS, right?
I can confirm I have read that trait as being one of the desirable ones over holding individual TIPS. Personally, I own both funds and individual TIPS. Vanguard, annoyingly, doesn't offer a long-term TIPS fund, and LTPZ has got a high expense ratio compared to Vanguard.
LTPZ is the only game in town for most investors who want a long term TIPs fund. And while that e/r is higher than most index funds at Vanguard, I wouldn't exactly call it high at 0.20%

That said, I'm actually surprised that other providers haven't jumped in to offer some competition. Perhaps with all of the recent inflation talk, that'll change.

Cheers.
That 0.2% has to be some easy money. Once a year they buy the new bond and then what? What do they do all day?
Nothing. Robots do it. :-D
Nice gig.
We plan. G-d laughs.
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