New TIPS vs Old TIPS

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SCV_Lawyer
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Joined: Sun Nov 20, 2016 3:24 pm

New TIPS vs Old TIPS

Post by SCV_Lawyer » Sun Jan 14, 2018 11:33 am

I am planning to build a TIPS ladder to bridge the years after retirement and before SS kicks in (likely delay until 70). I am using the #cruncher spreadsheet, which is a great tool. For all maturity years from now through 2029, there are 2 or 3 TIPS one can choose for each rung of the ladder. Different elections don't have that much effect on overall ladder pricing. If for later year, you choose the TIPS with a higher yield, it costs more, but then you can buy fewer TIPS in the ealier years since that higher yield supplements the income in the earlier years.

But there is one consideration I was thinking about as to why one might want to always choose the most recently issued TIPS. One of the nice things about TIPS is that the inflation-adjusted principal due on maturity can never be below $1000 (although for interest calculation purposes, the TIPS balance can go below $1000). This protection against possible deflation is diminished if one buys a TIPS issued many years ago, where the inflation-adjusted princiapal is, say, $1200. If there is significant deflation, one could lose 17% on such a TIPS at maturity.

Although one buys TIPS to hedge against unexpected higher inflation, we can never predict whether deflation will ever reappear. It doesn't seem like TIPS pricing accounts for this, else the older TIPS with the higher principal balance would always have a higher YTM to offset for the deflation risk. That doesn't seem to be true in the current pricing.

Am I thinking about this correctly, or missing something?

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Doc
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Re: New TIPS vs Old TIPS

Post by Doc » Sun Jan 14, 2018 1:10 pm

You've got most of the points.

In the '08 crisis there was some indication that deflation fears (not actual deflation) affected the price of older TIPS compared to on the run issues. It's probably not very important.

There are tax considerations for TIPS that can make a small difference for different coupons with the same real yield. The dollar amount is not too important but the bookkeeping can be a PITA and the brokers aren't really up to speed yet on the fine points in many cases.

You might want to take a look at Vanguards "bond ladder" page. It is easy to use and has some very nice visuals.


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A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

mindbogle
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Re: New TIPS vs Old TIPS

Post by mindbogle » Mon Jan 15, 2018 12:36 pm

The TIPS market certainly does price in the deflation floor. But its difficult to detect without sophisticated pricing models. TIPS prices and yields for bonds of similar maturities are affected by coupon differences, seasonality, and deflation floor. If you want a deflation floor, you will pay for it - trust the market!

MB

MtnBiker
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Re: New TIPS vs Old TIPS

Post by MtnBiker » Mon Jan 15, 2018 12:41 pm

SCV_Lawyer wrote:
Sun Jan 14, 2018 11:33 am

Although one buys TIPS to hedge against unexpected higher inflation, we can never predict whether deflation will ever reappear. It doesn't seem like TIPS pricing accounts for this, else the older TIPS with the higher principal balance would always have a higher YTM to offset for the deflation risk. That doesn't seem to be true in the current pricing.

Am I thinking about this correctly, or missing something?
What you say about older TIPS having higher YTM seems to me to be true for TIPS with longer maturities. I don't understand why the yields of shorter maturities are all over the place. Is it related to accrued interest?

grok87
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Re: New TIPS vs Old TIPS

Post by grok87 » Mon Jan 15, 2018 2:14 pm

MtnBiker wrote:
Mon Jan 15, 2018 12:41 pm
SCV_Lawyer wrote:
Sun Jan 14, 2018 11:33 am

Although one buys TIPS to hedge against unexpected higher inflation, we can never predict whether deflation will ever reappear. It doesn't seem like TIPS pricing accounts for this, else the older TIPS with the higher principal balance would always have a higher YTM to offset for the deflation risk. That doesn't seem to be true in the current pricing.

Am I thinking about this correctly, or missing something?
What you say about older TIPS having higher YTM seems to me to be true for TIPS with longer maturities. I don't understand why the yields of shorter maturities are all over the place. Is it related to accrued interest?
once you get to maturities of say a year or less, the actual nitty gritty details of inflation matter. tips work off unadjusted cpi, which actually can be pretty volatile month on month.
Keep calm and Boglehead on. KCBO.

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