Can a TIPS ladder 'fail' ?

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Dudley
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Can a TIPS ladder 'fail' ?

Post by Dudley » Sun Jul 23, 2017 5:24 am

I've seen a few vague comments made in passing that, under certain circumstances, a TIPS ladder strategy could 'fail' ?
What would people mean by that ? Surely each rung of a TIPS ladder is guaranteed to pay out at maturity in real terms at least what was put into it (ignoring tax) ? I understand a TIPS ladder may or may not be as profitable as a ladder or regular bonds depending how interests rates/inflation unfold, but under what circumstances could it lose money in real terms (again taxes aside) ?

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Re: Can a TIPS ladder 'fail' ?

Post by furwut » Sun Jul 23, 2017 6:47 am

Here are 2 scenarios:
1) You setup a ladder of, say 30 years, and you live 31 or more.
2) You have unanticipated spending and are forced to redeem some portion of the ladder early.

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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Sun Jul 23, 2017 6:49 am

Dudley wrote:I've seen a few vague comments made in passing that, under certain circumstances, a TIPS ladder strategy could 'fail' ?
What would people mean by that ? Surely each rung of a TIPS ladder is guaranteed to pay out at maturity in real terms at least what was put into it (ignoring tax) ? I understand a TIPS ladder may or may not be as profitable as a ladder or regular bonds depending how interests rates/inflation unfold, but under what circumstances could it lose money in real terms (again taxes aside) ?
Rates of return on some TIPS are now negative in real terms. If inflation is as expected, you will *lose* money.

Unless you buy zero coupon TIPS (government does not issue them, but probably some broker strips them? As they do with US Treasury bonds?) then you have reinvestment risk. At the moment, because it is in the short TIPS that have (had?) negative real returns, each coupon would be reinvested at a lower real rate (negative)-- in fact as the yield curve is normally upward sloping, this is going to prove to be an ongoing problem, even if "normal" real interest rates resume-- your coupons will be reinvested at a lower real yield. Although that latter transition would be a good thing for the TIPS investor (who is still reinvesting).

Otherwise, and without googling "TIPS ladder failure", I cannot think what they are thinking of. Credit risk on the US government?

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Re: Can a TIPS ladder 'fail' ?

Post by AlohaJoe » Sun Jul 23, 2017 8:36 am

The TIPS inflation adjustment lags actual inflation. That is, based on the inflation in January to June they will adjust the rate in July. But during January to June you will have lost money if inflation was more than the rate set in January. In practice this slippage is extraordinarily small and really only comes into play in near hyperinflation regimes.

TIPS are not available for all possible maturities, meaning you are exposed to some reinvestment risk. That is, there is no 35-year TIPS so you need to buy a 30-year TIPS and then when it matures buy a 5-year TIPS. Imagine you had a 30 year TIPS that matured in 2013, you need to roll it over but TIPS are paying a negative real rate. That definitely wouldn't have been in any of your calculations. So the ladder "failed".

Your personal rate of inflation might not match the CPI used to adjust TIPS. Maybe your rent (or assessed property tax) in SF goes up by more than 1.8% a year.

As mentioned above, you may outlive the ladder.

All of these are somewhat theoretical concerns (except for unexpected large future expenses but that problem isn't unique to TIPS) and not something most investors should lose any sleep over. Even when you suffer from reinvestment risk it usually means losing 1% for a few years, which most people can handle easily since they probably had at least some sort of margin of safety built into their plans.

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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Sun Jul 23, 2017 9:10 am

AlohaJoe wrote:The TIPS inflation adjustment lags actual inflation. That is, based on the inflation in January to June they will adjust the rate in July. But during January to June you will have lost money if inflation was more than the rate set in January. In practice this slippage is extraordinarily small and really only comes into play in near hyperinflation regimes.
You may be thinking of I-bonds not TIPS. I am not familiar with the I-bond detail but I know that they are different than TIPS is some respects.

TIPS adjusted principle is adjusted for inflation daily based on a ~2.5 month lag of the CPI. Each coupon is adjusted to the then current principal and thus is subject to the same 2.5 month lag to the CPI.
TIPS pay interest every six months. The interest rate is a fixed rate determined at auction. Though the rate is fixed, interest payments vary because the rate is applied to the adjusted principal.
https://www.treasurydirect.gov/indiv/re ... _rates.htm
More specifically, the principal amount of the TIIS increases daily by an amount determined by the increase in the CPI measure between the third and second preceding months—the minimum indexation lag possible given the timing of the CPI data release.
https://www.newyorkfed.org/medialibrary ... 05sack.pdf

(Side note. I see at the time of the New York Fed article they were still using the TISS acronym "Treasury Inflation-Indexed Securities". :D )
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Re: Can a TIPS ladder 'fail' ?

Post by nisiprius » Sun Jul 23, 2017 9:15 am

There is always "reinvestment risk." It could fail if new TIPS are not being issued by the Treasury at the time when you need to roll over one that matured. During the brief period when the U.S. had a budget surplus there actually were times when I wanted to buy one and the Treasury was not issuing them.

I don't know if there's a possibility of TIPS being issued with negative real interest rates.

Income tax is assessed on nominal dollar gains, not real (inflation-adjusted) gains. If the CPI doubles and an investment doubles in dollar, you are behind in real terms because of taxes. So, TIPS, like other investments (e.g. stocks during the period from 1966 through 1982) could keep up with inflation before taxes, but not after taxes. This isn't unique to TIPS but it is an important footnote, because the first-approximation idea is that TIPS will always beat inflation, if only by a small amount, and it ain't necessarily so.

And then, of course, there are a variety of scenarios that all amount that all amount to the Treasury being unwilling or unable to meet the terms of a legal contract.
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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Sun Jul 23, 2017 9:52 am

nisiprius wrote: I don't know if there's a possibility of TIPS being issued with negative real interest rates.
US Treasury wrote:High Yield -0.049%

Auction results for 5-Year TIPS CUSIP Number 912828X39 April 20, 2017
https://www.treasurydirect.gov/instit/a ... 0420_1.pdf
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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Sun Jul 23, 2017 9:57 am

Back to the OP's question.

If you purchased your TIPS on the secondary market they would already have some inflation adjustment built into the "par" value. If we had subsequent deflation some of that adjustment would disappear but the adjusted value at maturity would never drop below the original par of $1000.

But I don't see this as a "failure".
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Re: Can a TIPS ladder 'fail' ?

Post by nedsaid » Sun Jul 23, 2017 10:04 am

Dudley wrote:I've seen a few vague comments made in passing that, under certain circumstances, a TIPS ladder strategy could 'fail' ?
What would people mean by that ? Surely each rung of a TIPS ladder is guaranteed to pay out at maturity in real terms at least what was put into it (ignoring tax) ? I understand a TIPS ladder may or may not be as profitable as a ladder or regular bonds depending how interests rates/inflation unfold, but under what circumstances could it lose money in real terms (again taxes aside) ?
Hard to say if a TIPS ladder could "fail." Seeing that these are US Treasury instruments essentially backed by the taxing power of the US and the printing press, it is hard to fathom that you wouldn't get your money plus CPI adjustments back when the individual TIPS matured. I just wonder about overloading a portfolio with these type of bonds, I have a natural feeling of caution. Somehow, just somehow, things don't always go according to plan and in a crisis, asset classes don't always act as expected. TIPS are a relatively new as an asset class and got unexpectedly hit hard during the 2008-2009 financial crisis. For me, I would have some other things working for me in retirement.
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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Sun Jul 23, 2017 1:22 pm

nedsaid wrote:
Dudley wrote:I've seen a few vague comments made in passing that, under certain circumstances, a TIPS ladder strategy could 'fail' ?
What would people mean by that ? Surely each rung of a TIPS ladder is guaranteed to pay out at maturity in real terms at least what was put into it (ignoring tax) ? I understand a TIPS ladder may or may not be as profitable as a ladder or regular bonds depending how interests rates/inflation unfold, but under what circumstances could it lose money in real terms (again taxes aside) ?
Hard to say if a TIPS ladder could "fail." Seeing that these are US Treasury instruments essentially backed by the taxing power of the US and the printing press, it is hard to fathom that you wouldn't get your money plus CPI adjustments back when the individual TIPS matured. I just wonder about overloading a portfolio with these type of bonds, I have a natural feeling of caution. Somehow, just somehow, things don't always go according to plan and in a crisis, asset classes don't always act as expected. TIPS are a relatively new as an asset class and got unexpectedly hit hard during the 2008-2009 financial crisis. For me, I would have some other things working for me in retirement.
The question would be "what is the investor's likely need for cash during a crisis?" Because TIPS were volatile in the crisis, but if you had a TIPS bond that was to be redeemed by the US Treasury during that period, it would have been so redeemed, as normal.

If there is a need for cash during a crisis and the investor is forced to sell long term assets, then they have not correctly matched assets and liabilities. As an investor one has to ask oneself the question "under what circumstances would I need emergency cash, and could I be forced to liquidate long term assets in order to get it?" Because if the answer to that is *yes* the investor needs to hold more cash and cash-like instruments.

It's important to note the 2008-09 volatility was because TIPS had been used as collateral in Repo ("Repurchase Obligation") transactions- -short term money market borrowings where the borrower gives title to collateral in return for cash, and when they repay the cash plus interest get the collateral back. This is perhaps the commonest financial transaction in financial markets. With the bankruptcy of Lehman Brothers and the freezing of the money markets, it was necessary for market participants to unwind their positions quite rapidly. TIPS were sold at what were, in retrospect, very attractive rates-- some like grok87 picked up quite a few at that time.

We discussed this many times here (and in fact I fingered what was going on, somewhat unknowingly, during Q4 of 2008-- Swedroe and others later confirmed it).

It's certainly possible that many US Treasury bonds were sold in the same way, at the same time. However straight US Treasuries are much more liquid, so the disruption of the market was much less.

The circumstances were quite extraordinary, and did not stem from something inherent to TIPS *except* their illiquidity. As long as one is cognizant that there can be such fluctuations, it's not an argument against TIPS. Redemption by the US Treasury will take place as normal, so the buy-and-hold investor will get $100/bond adjusted by CPI-U (with a several month time lag-- not sure how that is handled at redemption?).

TIPS are Real Return Bonds. And RRBs have been around a lot longer than TIPS. For example UK Indexed Linked Gilts (bonds issued by the British government) have been around since 1982. Canadian ones since the early 1990s.

In the case of deflation, US TIPS are protected in a unique way- -they redeem at 100 (although the coupons are reduced with a fall in the US CPI-U price index) even if the price index is lower than at issue. Thus, for any given pair of TIPS (maturing at close to the same date) the one with the higher nominal price (e.g. $137 v. $125, say) will have a slightly higher yield because they offer less deflation protection.

Another issue is that for tax paying accounts, higher inflation will lead to higher tax being paid on the TIPS-- significantly reducing inflation protection in such situations.

It's not right to worry that TIPS won't "work". They will-- by design-- at least for all the states of the world that were conceived of when they were created. Barring a tampering with the CPI-U, they will protect the holder against inflation as experienced. One should be aware there are many conspiracy threads about the CPI-U, but that the side that raises them has changed. Current evidence, and in particular the MIT "Billion Prices Project" which scrapes internet prices, suggests that CPI-U does accurately measure inflation within the limits of the index (i.e. that it is an "average" and none of us is "average" in our consumption).

If is fair to say that "never put all your eggs in one basket" is a good principle of diversification.

Whether they suit the investor need is a different matter. For example the negative yields now prevalent on some TIPS.

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Re: Can a TIPS ladder 'fail' ?

Post by nedsaid » Sun Jul 23, 2017 2:26 pm

Valuethinker, I think TIPS ladders are a great strategy. If people hold to maturity, there should not be a problem. Hopefully, people won't have to raise cash in another financial crisis and sell their TIPS before maturing. But pretty much, there is no default risk unless for some odd reason the US Government decides to default. It also helps to have your own bank which can act as buyer of last resort. What is even sweeter is that the bank's (the Fed) profits by law have to be returned to the Treasury. In a pinch, the US Government can get what amounts to an interest free loan from its own bank. The only other risk is if CPI adjustments don't keep up with the retiree's actual rate of inflation. But pretty much, TIPS ladders are as safe and inflation hedged as you can get.

So it isn't that I believe there will be a real problem with TIPS. It is that financial markets and the economy surprise me all of the time. It is just my natural caution.
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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Sun Jul 23, 2017 2:28 pm

Valuethinker wrote:In the case of deflation, US TIPS are protected in a unique way- -they redeem at 100 (although the coupons are reduced with a fall in the US CPI-U price index) even if the price index is lower than at issue.
Given the quote from the NY Fed I referenced above I don't think the coupon can ever be reduced below the original amount either.
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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Sun Jul 23, 2017 4:25 pm

nedsaid wrote:Valuethinker, I think TIPS ladders are a great strategy. If people hold to maturity, there should not be a problem. Hopefully, people won't have to raise cash in another financial crisis and sell their TIPS before maturing. But pretty much, there is no default risk unless for some odd reason the US Government decides to default. It also helps to have your own bank which can act as buyer of last resort. What is even sweeter is that the bank's (the Fed) profits by law have to be returned to the Treasury. In a pinch, the US Government can get what amounts to an interest free loan from its own bank. The only other risk is if CPI adjustments don't keep up with the retiree's actual rate of inflation. But pretty much, TIPS ladders are as safe and inflation hedged as you can get.

So it isn't that I believe there will be a real problem with TIPS. It is that financial markets and the economy surprise me all of the time. It is just my natural caution.
The question of a US default gets political too quickly so let's both acknowledge it and move on. I agree that since the US borrows in its own currency, it never needs to default.

We agree on the diversification point.

Your caution is well advised given what financial markets can throw up ;-). Although Zvi Bodie suggested it, I'd never suggest to someone they be 100% TIPS. Or even 100% cash equivalents unless very special circumstances. Indeed in looking at straight bonds, an 20% equity/ 80% bond portfolio has given a higher return for lower volatility than a 100% bond one.

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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Sun Jul 23, 2017 4:25 pm

Doc wrote:
Valuethinker wrote:In the case of deflation, US TIPS are protected in a unique way- -they redeem at 100 (although the coupons are reduced with a fall in the US CPI-U price index) even if the price index is lower than at issue.
Given the quote from the NY Fed I referenced above I don't think the coupon can ever be reduced below the original amount either.
Ahhh.. it's a long time since I last read a TIPS prospectus. Didn't know that. Thank you.

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Re: Can a TIPS ladder 'fail' ?

Post by grok87 » Sun Jul 23, 2017 5:21 pm

As others have pointed out, if you hold to maturity there is no risk, assuming you are using it to fund "real" future spending needs.

But personally i'm not expecting to necessarily hold my tips ladder to maturity. I plan to keep buying 30 year tips till i am say 65. Sometime in my 80s i plan to sell off the remainder of my ladder and buy an inflation protected annuity with the proceeds. Since annuity rates are usually tied to long term interest rates, hopefully this will provide a good matching strategy for the price of the annuity.
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Re: Can a TIPS ladder 'fail' ?

Post by chinto » Sun Jul 23, 2017 7:42 pm

A TIPs ladder can easily fail if the goods and services you purchase outpace the real rate of return generated by TIPs. Given taxes and the basket of goods most likely purchased in retirement, I think the odds are pretty darn high long lived retirees are ill served by TIPs.

For awhile I had a personal basket of goods I tracked that made up my personal budget. That experience led me to believe TIPs were simply not suitable for the purpose for which they were intended at the individual level.
Last edited by chinto on Sun Jul 23, 2017 7:47 pm, edited 3 times in total.

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Re: Can a TIPS ladder 'fail' ?

Post by FIREchief » Sun Jul 23, 2017 7:44 pm

chinto wrote:I think the odds are pretty darn high long lived retirees are ill served by TIPs.
So if a retiree shouldn't own TIPS, what should they bet their future on?
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Re: Can a TIPS ladder 'fail' ?

Post by chinto » Sun Jul 23, 2017 8:14 pm

FIREchief wrote:
chinto wrote:I think the odds are pretty darn high long lived retirees are ill served by TIPs.
So if a retiree shouldn't own TIPS, what should they bet their future on?
I do not have a definitive answer. I am planning on using 10 years of income in CDs, index mutual funds, and private equity holdings for the rst and a 1.6-1.8%% withdraw rate to cover what may be 50 years in retirement (the woman's possible life expectancy). Note, you can't buy 50 years TIPs anyways.

I would strongly encourage anyone, to create their own basket of goods and give it a trail run on paper.

For instance 80% of my grocery shopping is done at ALDI. This year ALDI has been ratcheting up the prices by decreasing the contents of the package and raising prices in many case or reducing content and dropping prices a little to create an illusion of value. The reason I mention this is when you shop at extreme discounters like ALDI the idea of the substitution effect doesn't really apply. The area of my budget that are largest are property taxes, medical insurance and food. All three have been on an upward trajectory that far outpaces inflation, much less inflation less taxes. The one discretionary item I have is soda, and my brands have pretty much stopped having large sales where I can stock up before the quality faades, so the price creep can bite into quality of life.
Last edited by chinto on Sun Jul 23, 2017 9:23 pm, edited 2 times in total.

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Re: Can a TIPS ladder 'fail' ?

Post by chinto » Sun Jul 23, 2017 8:18 pm

I suspect where TIPs work well are people who have a large amount of assets and have budgeted into their retirement a lot of discretionary, conspicuous consumption. Ergo the substitution effect ifs alive and well and the cost of some goods going up is balanced with other going down. But when most of your budget goes for non discretionary spending, it seems that you are taking on more risk than you may think with TIPs.
Last edited by chinto on Mon Jul 24, 2017 4:14 pm, edited 1 time in total.

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Re: Can a TIPS ladder 'fail' ?

Post by VictoriaF » Sun Jul 23, 2017 8:26 pm

A "ladder" invokes an unfortunate analogy. A ladder to climb to the roof frequently fails. In contrast, a TIPS ladder is a stairway to heaven.

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Re: Can a TIPS ladder 'fail' ?

Post by FIREchief » Sun Jul 23, 2017 9:35 pm

VictoriaF wrote:A "ladder" invokes an unfortunate analogy. A ladder to climb to the roof frequently fails. In contrast, a TIPS ladder is a stairway to heaven.

Victoria
Well put!! 8-) (however, if your roof ladders are frequently failing, you need to find a new hardware store)

It appears to me, from many of the thread responses, that posters are assuming the OP was discussing a TIPS ladder that constituted 100% of that persons assets; and that it was comprised of only enough money to pay expected expenses for expected life (i.e. no "wiggle room"). If that was the intent, then I don't know what should be recommended beyond either cutting expenses or working longer. Otherwise, a 100% TIPS ladder might have one or two possible failure modes, but that is a whole lot less than most/all alternatives. :annoyed
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Re: Can a TIPS ladder 'fail' ?

Post by indexonlyplease » Sun Jul 23, 2017 9:55 pm

chinto wrote:
FIREchief wrote:
chinto wrote:I think the odds are pretty darn high long lived retirees are ill served by TIPs.
So if a retiree shouldn't own TIPS, what should they bet their future on?
I do not have a definitive answer. I am planning on using 10 years of income in CDs, index mutual funds, and private equity holdings for the rst and a 1.6-1.8%% withdraw rate to cover what may be 50 years in retirement (the woman's possible life expectancy). Note, you can't buy 50 years TIPs anyways.

I would strongly encourage anyone, to create their own basket of goods and give it a trail run on paper.

For instance 80% of my grocery shopping is done at ALDI. This year ALDI has been ratcheting up the prices by decreasing the contents of the package and raising prices in many case or reducing content and dropping prices a little to create an illusion of value. The reason I mention this is when you shop at extreme discounters like ALDI the idea of the substitution effect doesn't really apply. The area of my budget that are largest are property taxes, medical insurance and food. All three have been on an upward trajectory that far outpaces inflation, much less inflation less taxes. The one discretionary item I have is soda, and my brands have pretty much stopped having large sales where I can stock up before the quality faades, so the price creep can bite into quality of life.
I can see the future when one shops at ALDI and looking for cheap prices on soda. Quiting those 2 will increase the return on your portfolio from less doctors. Sorry just being funny.

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Re: Can a TIPS ladder 'fail' ?

Post by chinto » Sun Jul 23, 2017 10:19 pm

indexonlyplease wrote: I can see the future when one shops at ALDI and looking for cheap prices on soda. Quiting those 2 will increase the return on your portfolio from less doctors. Sorry just being funny.
My everyday beverage is Mexican Coke, bottled in Mexico (made with cane sugar). The trouble with it is the bottles are not well sealed and slowly leak carbonation. So when you can find it on sale you really cannot stock up beyond a month. It is cheaper than the other can sugar sodas I drink, hence it is my everyday beverage.

I also drink Mexican Pepsi, RC with sugar cane and Dr Pepper or Boylan's Black Cherry all with sugar cane but those are not my everyday beverage. On rare occasion I go in for Virgil's Rootbeer of Spechers Grape, Puma Kola. Nothing at ALDI or anywhere else is going to substitute. well.

Sigh, just a few years ago I use to have client's who could not afford my hourly rates send me two cases of Dr Pepper Dublin and a box of apples from AppleSource as payments, but alas AppleSource is gone and Dr Pepper Dublin is no longer allowed to bottle and sell: ( I have one case left...little 6 oz bottles. It brings tears to me eyes thinking of it.

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Re: Can a TIPS ladder 'fail' ?

Post by indexonlyplease » Mon Jul 24, 2017 6:40 am

chinto wrote:
indexonlyplease wrote: I can see the future when one shops at ALDI and looking for cheap prices on soda. Quiting those 2 will increase the return on your portfolio from less doctors. Sorry just being funny.
My everyday beverage is Mexican Coke, bottled in Mexico (made with cane sugar). The trouble with it is the bottles are not well sealed and slowly leak carbonation. So when you can find it on sale you really cannot stock up beyond a month. It is cheaper than the other can sugar sodas I drink, hence it is my everyday beverage.

I also drink Mexican Pepsi, RC with sugar cane and Dr Pepper or Boylan's Black Cherry all with sugar cane but those are not my everyday beverage. On rare occasion I go in for Virgil's Rootbeer of Spechers Grape, Puma Kola. Nothing at ALDI or anywhere else is going to substitute. well.

Sigh, just a few years ago I use to have client's who could not afford my hourly rates send me two cases of Dr Pepper Dublin and a box of apples from AppleSource as payments, but alas AppleSource is gone and Dr Pepper Dublin is no longer allowed to bottle and sell: ( I have one case left...little 6 oz bottles. It brings tears to me eyes thinking of it.
That's funny story. I brings tears to my eyes all the sugar. But hey enjoy, we all have some bad habit.

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Re: Can a TIPS ladder 'fail' ?

Post by Dudley » Mon Jul 24, 2017 7:43 am

All, thanks for the replies to my post. I wish I could find the original comment that triggered my original question (I searched again but failed) - I think it was posted on this forum by someone well regarded thats why it puzzled me.
Just for context and your information, I have a healthy sum (10M) and considering early retirement at 51. I'm targeting a portfolio 20% stocks/80 bonds as that seems sweet spot for low volatility. Stocks to be split 1:2 US and non-US index. About 20% is in vanguard muni funds of duration ~4yr. The rest (bulk) is currently going into ladder of regular discrete US treasury notes of 5 to 7 years maturity. I understand this treasury exposure does nothing more than roughly match inflation at this stage with low risk. I currently have no TIPS but if/(when?) in the future their real yields rose to some level (tbd?) I think it would make sense to start rolling some of the regular notes to 10yr TIPS to lock in and guarantee some noticeable return above inflation. (alternatively, or additionally, if/when stock market become less richly valued increase exposure to that). Thats why I've been wondering if there are any obvious inherent risks in holding TIPS to maturity that I'm not aware of.

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Re: Can a TIPS ladder 'fail' ?

Post by Artsdoctor » Mon Jul 24, 2017 8:22 am

There might be some confusion here. As in anything else, it's important to get your terms correct.

Your question has to do with TIPS ladder FAILING. In order to "fail," they would have to not meet your expectations.

You're talking about rolling ladders, not spending the accrued principal when it matures. There is a big difference between these two goals.

So before we go off on different tangents, you might want to back up and state exactly what it is that you're expecting out of your TIPS ladder.

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Re: Can a TIPS ladder 'fail' ?

Post by Dudley » Mon Jul 24, 2017 8:35 am

So before we go off on different tangents, you might want to back up and state exactly what it is that you're expecting out of your TIPS ladder.
Each rung at maturity delivers greater or equal in real terms that at which it was bought at. What else could or should one expect of it ?
So from previous replies it would appear the only reasons it would not do this if there were disconnect in actual vs applied inflation or default.

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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Mon Jul 24, 2017 8:58 am

Dudley wrote:
So before we go off on different tangents, you might want to back up and state exactly what it is that you're expecting out of your TIPS ladder.
Each rung at maturity delivers greater or equal in real terms that at which it was bought at. What else could or should one expect of it ?
So from previous replies it would appear the only reasons it would not do this if there were disconnect in actual vs applied inflation or default.
Read investment of coupons is your Other risk. Short tips yield Less than long tips, and real yields could fall further.

With 10 million I would want to have exposure to rental real estate (your principal residence would do). And quite a lot of international exposure in equities.

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Re: Can a TIPS ladder 'fail' ?

Post by hirlaw » Mon Jul 24, 2017 9:42 am

A TIPs ladder can easily fail if the goods and services you purchase outpace the real rate of return generated by TIPs. Given taxes and the basket of goods most likely purchased in retirement, I think the odds are pretty darn high long lived retirees are ill served by TIPs.
+1 Just think of the rise in healthcare expenses alone this year. The "inflation rate" does not necessarily cover the rising cost of goods/services retirees ordinarily purchase.

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Re: Can a TIPS ladder 'fail' ?

Post by Kalo » Mon Jul 24, 2017 1:11 pm

My concern related to TIPS is that frankly I don't understand them, and I believe strongly in the adage that you should not invest in things you don't understand. I don't think it matters what causes this lack of understanding. It is going to be hard to stick with something that I am not totally clear on. Just looking up the sec yield on Vanguard's web site gives a footnote. And ladders require reinvestment of coupon payments and a spreadsheet to figure that out. I would not be afraid of default or even that they didn't track general rates of inflation. But I wouldn't know how much to buy for my ladder, and I'm not even senile yet. I'm not setting anything up that will require significant management in later years. I've witnessed mental decline among family members. I plan to make things simpler as I age, not more complex.

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Re: Can a TIPS ladder 'fail' ?

Post by chinto » Mon Jul 24, 2017 2:31 pm

indexonlyplease wrote:
chinto wrote:
indexonlyplease wrote: I can see the future when one shops at ALDI and looking for cheap prices on soda. Quiting those 2 will increase the return on your portfolio from less doctors. Sorry just being funny.
My everyday beverage is Mexican Coke, bottled in Mexico (made with cane sugar). The trouble with it is the bottles are not well sealed and slowly leak carbonation. So when you can find it on sale you really cannot stock up beyond a month. It is cheaper than the other can sugar sodas I drink, hence it is my everyday beverage.

I also drink Mexican Pepsi, RC with sugar cane and Dr Pepper or Boylan's Black Cherry all with sugar cane but those are not my everyday beverage. On rare occasion I go in for Virgil's Rootbeer of Spechers Grape, Puma Kola. Nothing at ALDI or anywhere else is going to substitute. well.

Sigh, just a few years ago I use to have client's who could not afford my hourly rates send me two cases of Dr Pepper Dublin and a box of apples from AppleSource as payments, but alas AppleSource is gone and Dr Pepper Dublin is no longer allowed to bottle and sell: ( I have one case left...little 6 oz bottles. It brings tears to me eyes thinking of it.
That's funny story. I brings tears to my eyes all the sugar. But hey enjoy, we all have some bad habit.
I have always found, it is the little everyday pleasures that gives life it zest. For me a bike ride, a swim, a romp in the hay with the lady of my choice, a cold soda, a tree ripe peach, and a chicken made on my Ronco rotisserie, well that is a day from heaven.

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Re: Can a TIPS ladder 'fail' ?

Post by indexonlyplease » Mon Jul 24, 2017 2:42 pm

chinto wrote:
indexonlyplease wrote:
chinto wrote:
indexonlyplease wrote: I can see the future when one shops at ALDI and looking for cheap prices on soda. Quiting those 2 will increase the return on your portfolio from less doctors. Sorry just being funny.
My everyday beverage is Mexican Coke, bottled in Mexico (made with cane sugar). The trouble with it is the bottles are not well sealed and slowly leak carbonation. So when you can find it on sale you really cannot stock up beyond a month. It is cheaper than the other can sugar sodas I drink, hence it is my everyday beverage.

I also drink Mexican Pepsi, RC with sugar cane and Dr Pepper or Boylan's Black Cherry all with sugar cane but those are not my everyday beverage. On rare occasion I go in for Virgil's Rootbeer of Spechers Grape, Puma Kola. Nothing at ALDI or anywhere else is going to substitute. well.

Sigh, just a few years ago I use to have client's who could not afford my hourly rates send me two cases of Dr Pepper Dublin and a box of apples from AppleSource as payments, but alas AppleSource is gone and Dr Pepper Dublin is no longer allowed to bottle and sell: ( I have one case left...little 6 oz bottles. It brings tears to me eyes thinking of it.
That's funny story. I brings tears to my eyes all the sugar. But hey enjoy, we all have some bad habit.
I have always found, it is the little everyday pleasures that gives life it zest. For me a bike ride, a swim, a romp in the hay with the lady of my choice, a cold soda, a tree ripe peach, and a chicken made on my Ronco rotisserie, well that is a day from heaven.
I like it. Yes that is a good day.

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Re: Can a TIPS ladder 'fail' ?

Post by Angst » Mon Jul 24, 2017 3:04 pm

Valuethinker wrote:
Dudley wrote:
So before we go off on different tangents, you might want to back up and state exactly what it is that you're expecting out of your TIPS ladder.
Each rung at maturity delivers greater or equal in real terms that at which it was bought at. What else could or should one expect of it ?
So from previous replies it would appear the only reasons it would not do this if there were disconnect in actual vs applied inflation or default.
Read investment of coupons is your Other risk. Short tips yield Less than long tips, and real yields could fall further. [Snip...]

For me personally, all I want or "expect" in real terms from my growing LMP's 2017 purchase at auction of $X,000 TIPS is its real purchase price equivalent 30 years from now, coupons are secondary. Now of course I'm also pleased to collect the annual coupon payments on top of that, but they have nothing to do with my expectations for my LMP for a real purchase price equivalent 30 years from now. And the fact that I do get coupon payments annually in addition to my guaranteed real $X,000 30 years from now, I'm essentially guaranteed something greater than 0% real return, all coupon reinvestment risk aside. It's just coupon gravy to me, they'll all get thrown back into the portfolio hopper for reinvestment like any other dividends from FI or equity.

There's no way I'd want to complicate things by trying to figure out how to reinvest coupons semi-annually for 29 1/2 years out, 29 years out, 28 1/2 years out... it's not going to happen! Now I Bonds will do that for you, but their real rates range from 0 to minuscule compared to TIPS. If one wants to lock in a 30-yr rung in a true LMP, there's really no substitute for a 30-yr purchase at auction. And all this talk of waiting for real rates to rise back up to more normal levels is to me a distraction from the fundamental task at hand which can be accomplished now. And then next year, or 5 years from now, 10 years from now... who knows if TIPS will even be sold anymore? Let alone where real rates are going to be? And as long as you are buying at auction, your purchase price will be returned in full purchase price real dollars, 30 years from now, all coupon gravy aside. But if you wait a year or longer and then buy this rung at an interest rate driven premium, no longer can you be so cavalier about those coupons as I, if you want that absolute real purchase price guarantee at maturity.

There's nothing better than buying one's rungs at auction, and I think that there is too much hand-wringing over reinvestment risk (of coupons, not ladder rungs) and fear of inappropriately low real rates.

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Re: Can a TIPS ladder 'fail' ?

Post by jalbert » Mon Jul 24, 2017 3:14 pm

Dudley wrote:I've seen a few vague comments made in passing that, under certain circumstances, a TIPS ladder strategy could 'fail' ?
What would people mean by that ? Surely each rung of a TIPS ladder is guaranteed to pay out at maturity in real terms at least what was put into it (ignoring tax) ? I understand a TIPS ladder may or may not be as profitable as a ladder or regular bonds depending how interests rates/inflation unfold, but under what circumstances could it lose money in real terms (again taxes aside) ?
Your personal inflation rate may deviate significantly from CPI-U, which is used to adjust TIPs principal (and to do colas on SS).
Risk is not a guarantor of return.

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Re: Can a TIPS ladder 'fail' ?

Post by VictoriaF » Mon Jul 24, 2017 3:15 pm

Angst wrote:For me personally, all I want or "expect" in real terms from my growing LMP's 2017 purchase at auction of $X,000 TIPS is its real purchase price equivalent 30 years from now, coupons are secondary. Now of course I'm also pleased to collect the annual coupon payments on top of that, but they have nothing to do with my expectations for my LMP for a real purchase price equivalent 30 years from now. And the fact that I do get coupon payments annually in addition to my guaranteed real $X,000 30 years from now, I'm essentially guaranteed something greater than 0% real return, all coupon reinvestment risk aside. It's just coupon gravy to me, they'll all get thrown back into the portfolio hopper for reinvestment like any other dividends from FI or equity.

There's no way I'd want to complicate things by trying to figure out how to reinvest coupons semi-annually for 29 1/2 years out, 29 years out, 28 1/2 years out... it's not going to happen! Now I Bonds will do that for you, but their real rates range from 0 to minuscule compared to TIPS. If one wants to lock in a 30-yr rung in a true LMP, there's really no substitute for a 30-yr purchase at auction. And all this talk of waiting for real rates to rise back up to more normal levels is to me a distraction from the fundamental task at hand which can be accomplished now. And then next year, or 5 years from now, 10 years from now... who knows if TIPS will even be sold anymore? Let alone where real rates are going to be? And as long as you are buying at auction, your purchase price will be returned in full purchase price real dollars, 30 years from now, all coupon gravy aside. But if you wait a year or longer and then buy this rung at an interest rate driven premium, no longer can you be so cavalier about those coupons as I, if you want that absolute real purchase price guarantee at maturity.

There's nothing better than buying one's rungs at auction, and I think that there is too much hand-wringing over reinvestment risk (of coupons, not ladder rungs) and fear of inappropriately low real rates.
This is a prudent approach: protect your $X from inflation for 10 or 30 years and ignore the coupons. Are you paying attention to the real rates? Or $X today = $X (real) in 2047 is enough for you?

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Re: Can a TIPS ladder 'fail' ?

Post by munemaker » Mon Jul 24, 2017 3:30 pm

if not used properly:

Image

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Re: Can a TIPS ladder 'fail' ?

Post by Angst » Mon Jul 24, 2017 3:47 pm

[url=https://www.bogleheads.org/forum/viewtopic.php?f=10&t=224016&newpost=3463149#p3463149]In this post[/url], VictoriaF wrote:This is a prudent approach: protect your $X from inflation for 10 or 30 years and ignore the coupons. Are you paying attention to the real rates? Or $X today = $X (real) in 2047 is enough for you?

Victoria
Oh I do pay attention to real rates! Like a hobby, but yes: "$X today = $X (real) in 2047" is enough for me. Certainly it's my definition of the "matching" part of a "LMP". It's the safety, the insurance-like guarantee that is accomplished with my annual purchase that I'm after. Now I have to admit I'm only trying to match around 10-15% of my anticipated future liabilities, but SS and a small pension should fairly handily cover the rest. And my remaining "risk" portfolio may well be left pretty much where it's already been for many years, around 85% equity. But I might feel different about that over time - we'll see. In my late 70's I might covert some of that to a SPIA. Just to be clear though, I always want more gravy with my mashed potatoes!

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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Mon Jul 24, 2017 4:23 pm

Angst wrote:For me personally, all I want or "expect" in real terms from my growing LMP's 2017 purchase at auction of $X,000 TIPS is its real purchase price equivalent 30 years from now, coupons are secondary.
Except at a recent TIPS auction the real yield was negative which means you would not get your principal back in real terms.

So if that happens a lot in the future and with longer maturities the TIPS ladder idea would fail.

OK not very likely. But in "The Only Guide to a Winning Bond Strategy You'll Ever Need" by Swedroe and Hempen March 2006, there is a discussion that is based on real returns for a ten being in the 2% to 3% range historically. Today its like 0.5%. Ten years ago we would have said that was not very likely either.
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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Mon Jul 24, 2017 4:33 pm

Angst wrote:
Valuethinker wrote:
Dudley wrote:
So before we go off on different tangents, you might want to back up and state exactly what it is that you're expecting out of your TIPS ladder.
Each rung at maturity delivers greater or equal in real terms that at which it was bought at. What else could or should one expect of it ?
So from previous replies it would appear the only reasons it would not do this if there were disconnect in actual vs applied inflation or default.
Read investment of coupons is your Other risk. Short tips yield Less than long tips, and real yields could fall further. [Snip...]

For me personally, all I want or "expect" in real terms from my growing LMP's 2017 purchase at auction of $X,000 TIPS is its real purchase price equivalent 30 years from now, coupons are secondary. Now of course I'm also pleased to collect the annual coupon payments on top of that, but they have nothing to do with my expectations for my LMP for a real purchase price equivalent 30 years from now. And the fact that I do get coupon payments annually in addition to my guaranteed real $X,000 30 years from now, I'm essentially guaranteed something greater than 0% real return, all coupon reinvestment risk aside. It's just coupon gravy to me, they'll all get thrown back into the portfolio hopper for reinvestment like any other dividends from FI or equity.
This I find confusing.

The Yield to Maturity calculation takes into account coupons.

Otherwise your yield on a bond is very low.

What you are really describing is a zero coupon bond. Where the discount at purchase means that the capital gain at redemption, annualized, gives you a YTM-- there's no reinvestment of coupon necessary.

There's no way I'd want to complicate things by trying to figure out how to reinvest coupons semi-annually for 29 1/2 years out, 29 years out, 28 1/2 years out... it's not going to happen! Now I Bonds will do that for you, but their real rates range from 0 to minuscule compared to TIPS. If one wants to lock in a 30-yr rung in a true LMP, there's really no substitute for a 30-yr purchase at auction. And all this talk of waiting for real rates to rise back up to more normal levels is to me a distraction from the fundamental task at hand which can be accomplished now. And then next year, or 5 years from now, 10 years from now... who knows if TIPS will even be sold anymore? Let alone where real rates are going to be? And as long as you are buying at auction, your purchase price will be returned in full purchase price real dollars, 30 years from now, all coupon gravy aside. But if you wait a year or longer and then buy this rung at an interest rate driven premium, no longer can you be so cavalier about those coupons as I, if you want that absolute real purchase price guarantee at maturity.
So what you are saying is that a real yield of zero would be OK? That's what you are saying in other words.

Note that for some maturities of TIPSs, real yields are negative. What you want, you cannot get.
There's nothing better than buying one's rungs at auction, and I think that there is too much hand-wringing over reinvestment risk (of coupons, not ladder rungs) and fear of inappropriately low real rates.
Depends on how much money you have. If you don't need a real return on your investments, then that's great.

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Re: Can a TIPS ladder 'fail' ?

Post by Angst » Mon Jul 24, 2017 4:55 pm

Doc wrote:
Angst wrote:For me personally, all I want or "expect" in real terms from my growing LMP's 2017 purchase at auction of $X,000 TIPS is its real purchase price equivalent 30 years from now, coupons are secondary.
Except at a recent TIPS auction the real yield was negative which means you would not get your principal back in real terms.

So if that happens a lot in the future and with longer maturities the TIPS ladder idea would fail.

OK not very likely. But in "The Only Guide to a Winning Bond Strategy You'll Ever Need" by Swedroe and Hempen March 2006, there is a discussion that is based on real returns for a ten being in the 2% to 3% range historically. Today its like 0.5%. Ten years ago we would have said that was not very likely either.
Yes. Who knows where rates will be in 10 yrs? I'll trust the wisdom of the current yield curve before the BH crowd though - we've been expecting rates to rise for far too long. Will 30-yr TIPS ever go negative? Not very likely! There, I said it. :) Yes, I know. Even the 10-yr hasn't auctioned in negative territory for maybe 4 years now, I think. I'd buy my maximum of I Bonds long before buying a negative yield TIPS at auction. I don't want to think about the 30-yr going negative though. I don't imagine I'd buy it, but it hurts my brain to try to think what would be my logically consistent choice.

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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Mon Jul 24, 2017 5:23 pm

@Angst
Never say never. Sith happens.

That said I don't expect that the 30 will go negative. But if I was going to create a 30 year TIPS LMP under current conditions I would use triple rungs of ten's not single rungs of thirty's.
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Re: Can a TIPS ladder 'fail' ?

Post by Angst » Mon Jul 24, 2017 5:54 pm

In [url=https://www.bogleheads.org/forum/viewtopic.php?f=10&t=224016&newpost=3463349#p3463305]this post[/url], Valuethinker wrote:This I find confusing.

The Yield to Maturity calculation takes into account coupons.

Otherwise your yield on a bond is very low.

What you are really describing is a zero coupon bond. Where the discount at purchase means that the capital gain at redemption, annualized, gives you a YTM-- there's no reinvestment of coupon necessary.
[Snip...]
Valuethinker wrote:So what you are saying is that a real yield of zero would be OK? That's what you are saying in other words.

Note that for some maturities of TIPSs, real yields are negative. What you want, you cannot get.
[Snip...]
Valuethinker wrote:Depends on how much money you have. If you don't need a real return on your investments, then that's great.
VT, it appears we find each other's points confusing, although I probably ought to be more concerned than you, which is to say I highly respect your knowledge. I am building a ladder, one year at a time with annual 30-yr TIPS purchased at auction. If bought at auction, I understand that 30 years later these TIPS will pay at maturity "essentially" the full, inflation-adjusted equivalent of the original auction purchase price. The coupon payments I receive twice a year are certainly valuable to me, but I don't gather that what I choose to do with them has anything to do with my previous statement about my TIPS maturity value. So yes, as far as my intent to match a fixed level of 2017 purchasing power with an inflation-adjusted equivalent value in 2047, I guess I am looking at them as something of a "zero coupon" inflation-adjusted bond. I buy them for that reason, for insuring a portion of my future purchasing power. But 0% real is not the going rate on 30-yr TIPS, so I gladly accept my coupon payments and plow them back into my general investment portfolio. I get my insurance and on top of it I get some fairly small coupon payments twice a year for 30 years. That's the deal (I think!) I'm making. Does this help explain myself?

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Re: Can a TIPS ladder 'fail' ?

Post by Angst » Mon Jul 24, 2017 6:31 pm

Doc wrote:@Angst
Never say never. Sith happens.
It sure does!
Doc wrote:That said I don't expect that the 30 will go negative. But if I was going to create a 30 year TIPS LMP under current conditions I would use triple rungs of ten's not single rungs of thirty's.
Yes, I would have gathered this would be your way of doing it, but then it really wouldn't be "a 30 year TIPS LMP". I think maybe I'm just very conservative in this part of my investment portfolio (not so with my SCV equity tilting), it is all about matching a future 30-yr liability, not a 10-yr liability (which I do also have covered). I'm very much about the "bird in the hand" here. I've got 2047 locked in. Nothing more to worry about for 30 years. The ten's strategy introduces the risk that TIPS in general, or at least ten's in specific won't even exist in ten years. Note that I haven't even mentioned risks about where rates will be in ten years. That's because for me, the primary purpose is guaranteeing a specific future liability; getting a better coupon is nice, but not the main issue. There's just more uncertainty involved in the ten's strategy that is entirely eliminated by buying the 30-yr up front. And it's at a price I'm willing to pay. That said, I do look forward to the passage of time and learning how all these issues resolve. We'll have to revisit this in 2027. :beer

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Re: Can a TIPS ladder 'fail' ?

Post by FIREchief » Mon Jul 24, 2017 8:58 pm

Angst wrote:
For me personally, all I want or "expect" in real terms from my growing LMP's 2017 purchase at auction of $X,000 TIPS is its real purchase price equivalent 30 years from now, coupons are secondary. Now of course I'm also pleased to collect the annual coupon payments on top of that, but they have nothing to do with my expectations for my LMP for a real purchase price equivalent 30 years from now. And the fact that I do get coupon payments annually in addition to my guaranteed real $X,000 30 years from now, I'm essentially guaranteed something greater than 0% real return, all coupon reinvestment risk aside. It's just coupon gravy to me, they'll all get thrown back into the portfolio hopper for reinvestment like any other dividends from FI or equity.
Your position makes perfect sense. Unfortunately, many people try to treat (and evaluate) TIPS like nominal bonds. I read in another recent thread somebody who was unwilling to incur the "poor real yields" of TIPS, so was keeping a significant investment in nominal treasuries. What do they think the real yield of 5, 10 or 30 year treasuries will be??? (of course, we don't know, but that is largely the point; with TIPS we DO know)
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Re: Can a TIPS ladder 'fail' ?

Post by Doc » Tue Jul 25, 2017 8:43 am

Angst wrote:Yes, I would have gathered this would be your way of doing it, but then it really wouldn't be "a 30 year TIPS LMP". I think maybe I'm just very conservative in this part of my investment portfolio (not so with my SCV equity tilting), it is all about matching a future 30-yr liability, not a 10-yr liability (which I do also have covered). I'm very much about the "bird in the hand" here. I've got 2047 locked in.
I understand your reasoning even if I would take a different approach. What did you do for the missing rungs?

Unlike your approach many people build their TIPS LMP over a long period - sometimes as long as 30 years. Buying tens and not thirty's for the first ten years and then buying twice the amount of tens for the next ten using the maturing notes plus new money and repeating for the last 10 years gets you to the same place. But if you a concerned with the Treasury not issuing tens in the future your approach works if you have sufficient resources to buy it all now. It's likely more expensive given lower than historically normal real rates currently but as long as you are aware of it and you appear to be, there is nothing inherently wrong with the idea.
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Re: Can a TIPS ladder 'fail' ?

Post by Valuethinker » Tue Jul 25, 2017 10:32 am

Angst wrote:
In [url=https://www.bogleheads.org/forum/viewtopic.php?f=10&t=224016&newpost=3463349#p3463305]this post[/url], Valuethinker wrote:This I find confusing.

The Yield to Maturity calculation takes into account coupons.

Otherwise your yield on a bond is very low.

What you are really describing is a zero coupon bond. Where the discount at purchase means that the capital gain at redemption, annualized, gives you a YTM-- there's no reinvestment of coupon necessary.
[Snip...]
Valuethinker wrote:So what you are saying is that a real yield of zero would be OK? That's what you are saying in other words.

Note that for some maturities of TIPSs, real yields are negative. What you want, you cannot get.
[Snip...]
Valuethinker wrote:Depends on how much money you have. If you don't need a real return on your investments, then that's great.
VT, it appears we find each other's points confusing, although I probably ought to be more concerned than you, which is to say I highly respect your knowledge. I am building a ladder, one year at a time with annual 30-yr TIPS purchased at auction. If bought at auction, I understand that 30 years later these TIPS will pay at maturity "essentially" the full, inflation-adjusted equivalent of the original auction purchase price. The coupon payments I receive twice a year are certainly valuable to me, but I don't gather that what I choose to do with them has anything to do with my previous statement about my TIPS maturity value. So yes, as far as my intent to match a fixed level of 2017 purchasing power with an inflation-adjusted equivalent value in 2047, I guess I am looking at them as something of a "zero coupon" inflation-adjusted bond. I buy them for that reason, for insuring a portion of my future purchasing power. But 0% real is not the going rate on 30-yr TIPS, so I gladly accept my coupon payments and plow them back into my general investment portfolio. I get my insurance and on top of it I get some fairly small coupon payments twice a year for 30 years. That's the deal (I think!) I'm making. Does this help explain myself?
I am quite capable of being thick ;-). Volume of posts does not always correlate with quality ;-).

I understand what you are doing now.

Yes if you buy at issue (auction by US Treasury) then you will get back your principal in real terms (caveat below*).

If the bond is priced at a negative real yield (see below) then you would lose money, even including the coupons.

It's certainly conservative to not "count" the coupons, and I imagine for a lot of TIPS now that would push you into negative yield territory?

Does the US Treasury issue 30 year TIPS? The UK government in fact has gone to 50 years (Indexed Linked Gilts) on one or two issues. But out beyond 10 years there are plenty of gaps.


* caveat

That's true as long as the real yield at issue of the bonds is greater than or equal to zero. In current circumstances (I have not checked) for certain maturities of TIPS it's certainly possible that the auction price will exceed the redemption price i.e. on the principal only one would incur a loss of capital in real terms between purchase and redemption. That's simply a function of having negative TIPS yields.

** caveat 2

If held in a taxable account, then as I understand US taxation higher inflation will mean higher tax payments on the TIPS interest? That means inflation protection decreases for a TIPS held in a taxable account.

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Re: Can a TIPS ladder 'fail' ?

Post by FIREchief » Tue Jul 25, 2017 4:52 pm

Valuethinker wrote:It's certainly conservative to not "count" the coupons, and I imagine for a lot of TIPS now that would push you into negative yield territory?
This is not correct for "a lot of TIPS." The only TIPS currently providing a negative yield to maturity are maturing in under five years.
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Re: Can a TIPS ladder 'fail' ?

Post by #Cruncher » Tue Jul 25, 2017 4:57 pm

Valuethinker in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3461042#p3461042]this post[/url] wrote:Unless you buy zero coupon TIPS (government does not issue them, but probably some broker strips them? As they do with US Treasury bonds?) then you have reinvestment risk. ... as the yield curve is normally upward sloping, ... your coupons will be reinvested at a lower real yield.
Firstly, although the Treasury structures TIPS to allow "stripping", to my knowledge, no TIPS STRIPS are actually being marketed.

For a rolling bond ladder coupons are indeed subject to reinvestment risk. But for a non-rolling ladder this need not be the case. It's possible to include coupons along with principal redemptions in the ladder's income stream that will be spent and not reinvested. My TIPS Ladder Builder spreadsheet does this automatically for a ladder purchased on the secondary market. For example, to provide $30,000 per year each year from 2018-2047 only $17,000 face value maturing in 2018 needs to be purchased. The remaining $13,000 to be spent in 2018 comes from coupons on all the bonds maturing in 2019 and later.
AlohaJoe in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3461132#p3461132]this post[/url] wrote: TIPS are not available for all possible maturities, meaning you are exposed to some reinvestment risk. That is, there is no 35-year TIPS so you need to buy a 30-year TIPS and then when it matures buy a 5-year TIPS. Imagine you had a 30 year TIPS that matured in 2013, you need to roll it over but TIPS are paying a negative real rate. That definitely wouldn't have been in any of your calculations. So the ladder "failed".
Such an outcome could only be called a "failure" if one is expecting to get the 30-year's yield for 35 years. But such an expectation is unrealistic in my view, because there is no way to avoid such "reinvestment risk" for 35 years with bonds issued with a maximum term of 30 years. To be a real "risk", in my opinion, there must be some way that might avoid it. In this case, there is none.

A more realistic "risk" would relate to the years 2033-2039 when no TIPS mature. One wanting to build a 30-year ladder needs to decide how to "cover" these years. One way is to buy extra of the 2032 maturity; another is to buy extra of the 2040 maturity. Choosing the first exposes one to reinvestment risk; i.e., rates could be lower in 2032 when one plans to roll over some of the maturing TIPS into shorter term TIPS to mature in 2033-2039. But choosing to fund with the 2040 maturity exposes one to interest rate risk; i.e., rates could be higher in 2033-2039 as one sells off part of the 2040 holding each year.

To compromise between these two risks one could buy smaller extra amounts of both the 2032 and 2040. For example the default selection on the "Ladder" sheet of my TIPS Ladder Builder spreadsheet is to buy 5 times the normal amount of the 2032 to fund the years 2032-2036, and 4 times the normal amount of the 2040 to fund the years 2037-2040. (Of course one can change this.)
Doc in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3461558#p3461558]this post[/url] wrote:Given the quote from the NY Fed I referenced above I don't think the coupon can ever be reduced below the original amount either.
The coupon percent never changes. But I think, Doc, you mean more than this: that the interest payment can never be less than the coupon applied against the face amount. However, I don't see anything in the Fed quote from your post above to indicate this. On the contrary, as stated in the TreasuryDirect FAQ, What happens to TIPS if deflation occurs?:
The principal is adjusted downward, and your interest payments are less than they would be if inflation occurred or if the Consumer Price Index remained the same. You have this safeguard: at maturity, if the adjusted principal is less than the security's original principal, you are paid the original principal. (underlines added)
For example, the index ratio on the 2.125% 10-Year TIPS due January 15, 2019 declined from 1.0 to 0.99450 on its first interest payment date, July 15 2009. Holders therefore received less than $106.25 interest per $10,000 face value. (Can any forum member who held this bond, check his statements from 2009 to confirm this? Or provide a link to a web page that reports actual TIPS interest payments for specific issues.)
Dudley in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3462434#p3462434]thispost[/url] wrote:
Artsdoctor in previous post wrote:So before we go off on different tangents, you might want to back up and state exactly what it is that you're expecting out of your TIPS ladder.
Each rung at maturity delivers greater or equal in real terms that at which it was bought at.
As others have pointed out, Dudley, this is will not happen with TIPS purchased at a negative yield. This was the case with most 5-year TIPS purchased at auction since 2010 and all 10-year TIPS purchased at auction January 2012 to May 2013.

What you should expect is that, if held to maturity, you will receive, before taxes, the real yield at which the TIPS were purchased regardless of the level of inflation. And if held in a retirement account, you will also receive this real yield after taxes regardless of the level of inflation. See my post, Re: Is it time to give-up on TIPS?, for an illustration.
Kalo in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3462898#p3462898]this post[/url] wrote:... ladders require reinvestment of coupon payments and a spreadsheet to figure that out. ... I'm not setting anything up that will require significant management in later years. I've witnessed mental decline among family members. I plan to make things simpler as I age, not more complex.
Apart from handling the years when no TIPS mature (2030-2031 and 2033-2039), once set up, a non-rolling TIPS ladder in a retirement account doesn't require any management. For example, consider a 12-year ladder with TIPS maturing each year 2018-2029. When coupons are paid and principal redeemed, one just spends the money.

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SeeMoe
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Re: Can a TIPS ladder 'fail' ?

Post by SeeMoe » Tue Jul 25, 2017 5:55 pm

VictoriaF wrote:A "ladder" invokes an unfortunate analogy. A ladder to climb to the roof frequently fails. In contrast, a TIPS ladder is a stairway to heaven.

Yeah, but TIPS don't payout much compared to corporate bonds or regular treasury funds. They are almost as plain as short term CD's today. Paying out just chump change. Right?

SeeMoe.. :annoyed
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Re: Can a TIPS ladder 'fail' ?

Post by FIREchief » Tue Jul 25, 2017 6:05 pm

SeeMoe wrote: Yeah, but TIPS don't payout much compared to corporate bonds or regular treasury funds. They are almost as plain as short term CD's today. Paying out just chump change. Right?

SeeMoe.. :annoyed
If "payout" means the size of the semi-annual coupon payments, then you are right. If "payout" refers to the return of actual purchasing power, then you are mistaken (unless inflation suddenly drops significantly from current levels), especially with respect to nominal treasuries.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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