Thoughts on 5 year TIPS bonds?

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BlueEars
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Thoughts on 5 year TIPS bonds?

Post by BlueEars » Fri Oct 19, 2018 6:47 pm

Every once in awhile lately I mull buying some 5 year TIPS in retirement accounts. Maybe 10% of our FI to start with. 5 year TIPS because we are retired at age 70 and can easily hold to maturity. The current rates are starting to look tempting. Should I be tempted?

The current rate is 1.07%. Here is the bigger historical picture:

Image

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Re: Thoughts on 5 year TIPS bonds?

Post by Blueskies123 » Fri Oct 19, 2018 6:54 pm

If you buy a 5-year TIP bond you are betting that REAL interest rates are not going to rise. I have not idea what they will do, maybe they will go down in the next recession or maybe they will go up. Why 5 year and not 2 years.

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Re: Thoughts on 5 year TIPS bonds?

Post by Prokofiev » Fri Oct 19, 2018 7:06 pm

Right now, the TIPS yield curve is very flat. Real yields of 1.0 to 1.2%
I have bought a large amount of 2yr, 4yr and 5yr TIPS, with yields at 1.1%
I sold some of my longer maturities.That works for me. I can/might hold to maturity or sell them to get into the market if stock prices continue to tank.

For young people saving for the next 20-40 years, it is not very attractive. But if you are in retirement and looking for stable, inflation protected income and have enough to make 1% real work, go for it. By staying short you will preserve lots of options.



TIPS yield as of today . . .

wsj.com/mdc/public/page/2_3020-tips.html
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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Fri Oct 19, 2018 7:10 pm

Blueskies123 wrote:
Fri Oct 19, 2018 6:54 pm
If you buy a 5-year TIP bond you are betting that REAL interest rates are not going to rise. I have not idea what they will do, maybe they will go down in the next recession or maybe they will go up. Why 5 year and not 2 years.
Yes real rates could go up ... or down. If I hold to maturity it doesn't really matter except at the end of 5 years I would have to reinvest so that means some reinvestment risk. Caveat: I'm not a bond expert for sure.

I don't know where 2 year TIPS are at right now. 5 years seems a reasonable intermediate time frame for us.

FWIW, we have the following in our fixed income:
1% cash
18% Ibonds (3.4% fixed from 2001)
31% short term IG
50% intermediate term IG

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Re: Thoughts on 5 year TIPS bonds?

Post by willthrill81 » Fri Oct 19, 2018 7:21 pm

BlueEars wrote:
Fri Oct 19, 2018 7:10 pm
Blueskies123 wrote:
Fri Oct 19, 2018 6:54 pm
If you buy a 5-year TIP bond you are betting that REAL interest rates are not going to rise. I have not idea what they will do, maybe they will go down in the next recession or maybe they will go up. Why 5 year and not 2 years.
...

I don't know where 2 year TIPS are at right now. 5 years seems a reasonable intermediate time frame for us.
TIPS are only issued in terms of 5, 10, or 30 years. You can't buy two year TIPS from the Treasury.

https://www.treasurydirect.gov/indiv/re ... _rates.htm
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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Fri Oct 19, 2018 7:47 pm

Yes, I'd only buy 2 yr TIPS from VG on the secondary market.

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Sat Oct 20, 2018 10:10 am

Prokofiev wrote:
Fri Oct 19, 2018 7:06 pm
Right now, the TIPS yield curve is very flat. Real yields of 1.0 to 1.2%
I have bought a large amount of 2yr, 4yr and 5yr TIPS, with yields at 1.1%
I've been doing 2-3 year CDs at 3-3.2% in an IRA. I guess I should start looking at short term TIPS also, as I would not be surprised to see more than 2% inflation.

Is there a reason why the top two lines at your link show such high yields?
Image
http://wsj.com/mdc/public/page/2_3020-tips.html
press on, regardless - John C. Bogle

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Re: Thoughts on 5 year TIPS bonds?

Post by willthrill81 » Sat Oct 20, 2018 10:24 am

jeffyscott wrote:
Sat Oct 20, 2018 10:10 am
I've been doing 2-3 year CDs at 3-3.2% in an IRA. I guess I should start looking at short term TIPS also, as I would not be surprised to see more than 2% inflation.
The inflation rate was last reported to be 2.2%, so we're already there.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Sat Oct 20, 2018 11:02 am

willthrill81 wrote:
Sat Oct 20, 2018 10:24 am
jeffyscott wrote:
Sat Oct 20, 2018 10:10 am
I've been doing 2-3 year CDs at 3-3.2% in an IRA. I guess I should start looking at short term TIPS also, as I would not be surprised to see more than 2% inflation.
The inflation rate was last reported to be 2.2%, so we're already there.
Right, but short term TIPS only reached 1% real yield this month. Even the 5 year only hit 1% about 2 weeks ago. I have been getting 3-3.2% CDs since June or July.
press on, regardless - John C. Bogle

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Re: Thoughts on 5 year TIPS bonds?

Post by JackoC » Sat Oct 20, 2018 12:10 pm

BlueEars wrote:
Fri Oct 19, 2018 6:47 pm
Every once in awhile lately I mull buying some 5 year TIPS in retirement accounts. Maybe 10% of our FI to start with. 5 year TIPS because we are retired at age 70 and can easily hold to maturity. The current rates are starting to look tempting. Should I be tempted?

The current rate is 1.07%. Here is the bigger historical picture:
I recommend this site, by the Cleveland Fed, about inflation expectations. They run a model of market expected inflation and real rates which does not use TIPS as an input. Therefore, TIPS price/yield can be compared to the model output as a measure of cheapness/richness of TIPS, rather than just looking at the absolute real yield of TIPS. Various factors (inflation insurance premium, liquidity premium etc) affect the price of TIPS, and some discussions treat these as fixed, or ignore some of them (eg. 'you pay an inflation risk premium to buy TIPS, do you really want to?', but you also often get a liquidity premium for holding TIPS, do you really not want to get it? :D ). But they vary over time.

https://www.clevelandfed.org/our-resear ... tions.aspx
Click on "Ten-Year TIPS Yields versus Real Yields" as simplest thing to look at IMO. The Cleveland Fed's model output had TIPS looking cheap back around the turn of the century as a still sort of new product (first issued in 1997). Then historically cheap in the midst of the financial crisis (high liquidity premium), quite expensive when TIPS yields were mainly negative in 2012-13, since then not that cheap or expensive but have gotten a bit more expensive as real yields have increased lately, not cheaper as one might infer from just a higher real yield on TIPS.

It's just one model of course, but not from some off the wall guy on the internet.

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Re: Thoughts on 5 year TIPS bonds?

Post by Prokofiev » Sat Oct 20, 2018 1:29 pm

jeffyscott wrote:
Sat Oct 20, 2018 10:10 am
Prokofiev wrote:
Fri Oct 19, 2018 7:06 pm
Right now, the TIPS yield curve is very flat. Real yields of 1.0 to 1.2%
I have bought a large amount of 2yr, 4yr and 5yr TIPS, with yields at 1.1%
I've been doing 2-3 year CDs at 3-3.2% in an IRA. I guess I should start looking at short term TIPS also, as I would not be surprised to see more than 2% inflation.

Is there a reason why the top two lines at your link show such high yields?
Well, look at the included link . . .

Apr 2020 =1.139%
Apr 2002 =1.022%
Jan 2023 =1.022%
Jan 2025 =1.065%

All 2040 thru 2048 are yielding over 1.2%.
Are they not all between 1% and 1.25%? Isn't that pretty flat? Short term TIPS were strongly negative only 24 months ago.

I presently own maturities from Apr 2020 thru Apr 2029. Your actual YTM depends on lot size and whether you are buying or selling. I bought both the 2020 and 2025 this week at YTM of 1.1%
Everything should be made as simple as possible, but not simpler - Einstein

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Sat Oct 20, 2018 2:24 pm

Prokofiev wrote:
Sat Oct 20, 2018 1:29 pm
jeffyscott wrote:
Sat Oct 20, 2018 10:10 am
Is there a reason why the top two lines at your link show such high yields?
Well, look at the included link . . .

Apr 2020 =1.139%
Apr 2002 =1.022%
Jan 2023 =1.022%
Jan 2025 =1.065%

All 2040 thru 2048 are yielding over 1.2%.
Are they not all between 1% and 1.25%? Isn't that pretty flat?
Oh, sorry that was not clear. I was not disagreeing about the flatness.

Not knowing much about TIPS, I was just curious why the Jan 2019 one is at 1.7% and April 2019 is at 1.5%, higher than later ones. I am guessing it has something to do with how the semi-annual inflation adjustments work and those two bonds having less than 6 months to maturity?
press on, regardless - John C. Bogle

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Sat Oct 20, 2018 2:44 pm

Looking at the last 5 years, it appears that there is a marked rise in the 5 yearTIPS yield into December and then a decline into the early part of the next year. Well maybe December 2018 didn't quite qualify. Probably this is not a pattern to bet on but I just thought it interesting.

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Sat Oct 20, 2018 4:36 pm

According to Larry Swedroe the 5 year Treasury had a historical real return of 2.3% for 1926-2010.

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Re: Thoughts on 5 year TIPS bonds?

Post by Prokofiev » Sat Oct 20, 2018 5:55 pm

BlueEars wrote:
Sat Oct 20, 2018 4:36 pm
According to Larry Swedroe the 5 year Treasury had a historical real return of 2.3% for 1926-2010.
What has it been 2010-2018?

It might be quite a wait to get real yields above 2.3%, but maybe not. You could always scale into a position over a few weeks or months if you are convinced that real rates are still heading higher. But you do give up some yield by making many small purchases instead of a single large lot. You can easily check this using Vanguards bond buy/sell screen. Change the amounts and see the YTM change without actually buying anything. You can also see the spread by checking a purchase price for a given lot and immediately checking the sell price for the same amount. Over the past 10 years I have bought (and sold) many millions of $ of TIPS using the VG platform for the accounts I manage.
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Re: Thoughts on 5 year TIPS bonds?

Post by #Cruncher » Sun Oct 21, 2018 7:31 am

jeffyscott wrote:
Sat Oct 20, 2018 2:24 pm
... I was just curious why the Jan 2019 one is at 1.7% and April 2019 is at 1.5%, higher than later ones. I am guessing it has something to do with how the semi-annual inflation adjustments work and those two bonds having less than 6 months to maturity?
Your guess is partially right, Jeffy. But the TIPS inflation indexes (aka index ratios) are computed daily, not just every six months. [1] For TIPS maturing in the near future, the market estimates what these will be on the maturity date. It then adjusts today's price so that the nominal yield (i.e., the yield after adjusting for inflation) will be comparable to the yield on nominal Treasury securities maturing at the same time.

For example WSJ Treasury Quotes 10/19/2018 shows the 1.125% Note maturing 1/15/2019 (a normal Treasury -- not a TIPS) is currently yielding 2.247%. The market will price the TIPS also maturing on that date to have about the same yield after reflecting what it expects the index ratio to be on that date.

Turning this around we can determine what the market expects the index ratio to be for a particular TIPS on its maturity date. The following table shows how this can be done for the TIPS maturing 1/15/2019. Row 7 shows that the market is expecting the index ratio to be only 0.12% higher on 1/15/2019 than it is 10/22/2018. [2] Since all the index ratios are based on the Consumer Price Index (CPI), this means the market expects the daily interpolated "Reference CPI" [3] to rise only 0.12% between these two dates.

Code: Select all

Row  Col A                           Col B        Col C    Col D
  1  Face Value                  10,000.00
  2  Coupon                         2.125%
  3  Date                       10/22/2018   01/15/2019       85 days
  4  Price                      100.09375%   100.00000%
  5  Interest                        57.17       106.25
  6  Total Real Value            10,066.54    10,106.25   1.705% real yield
  7  Index ratio                   1.17420      1.17565   0.124% increase
  8  Inflation Adjusted Value    11,820.13    11,881.46   2.247% nominal yield
Notes:
  • B3: 10/22/2018 is the settlement date for purchases made 10/19. There are 85 days between settlement and maturity on 1/15/2019.
  • B4: The 100+3/32 price is the ask price from the WSJ TIPS Quotes 10/19/2018.
  • B5: $57.17 accrued interest = 10000 * (2.125% / 2) * (99 / 184) where 184 is the number of days in the 7/15/2018 to 1/15/2019 interest period.
  • D6: The computed 1.705% real yield is close to the WSJ's reported 1.712%.
    1.705% = (10106.28 / 10066.54) ^ (365 / 85) - 1
  • C7: 1.17565 index ratio is backed into based on $11,881.46 nominal value in C8 which in turn is backed into based on 2.247% nominal yield in D8.
    11,881.46 = 11820.13 * 1.02247 ^ (85 / 365)

  1. After the release of the September CPI earlier this month, we know the daily index ratios every day through 12/1/2018. For the January 2019 maturity this web page shows them to be 1.17420 for 10/22/2018 (the settlement date for a purchase on Friday) and 1.17578 for 12/1/2018. (Unfortunately the TreasuryDirect webpage only shows the index ratios through 11/30/2018.)
  2. The 1.17565 estimated index ratio on 1/15/2019 is 0.12% higher than the 1.17420 on 10/22/2018. But it is actually a touch less than the 1.17578 on 12/1/2018 -- the latest date for which index ratios are currently known. This means the market is expecting the monthly CPIs to be reported for October and November (the two months used to calculated calculate the Reference CPI for 1/15/2019) to be (on average) about the same as the September CPI (which is the Reference CPI for 12/1/2019 12/1/2018). The market's prediction includes its estimate of the effect of seasonality since the Treasury uses the non-seasonally adjusted CPI when indexing TIPS. (See the thread, Seasonal Indexation Impacts in TIPS Prices and Yields, for more on this.)
  3. For example the Reference CPI for 10/22/2018 is interpolated based on the July (252.006) and August (252.146)CPIs. (Choose U.S. All items, 1982-84=100 - CUUR0000SA0 on the BLS Top Picks webpage.)
    252.10084 = 252.006+ (21 / 31) * (252.146 - 252.006)
    This is used to compute every TIPS' corresponding index ratio by comparing it to the Reference CPI when each TIPS was first issued. For the January 2019 TIPS this was 214.69971 on 1/15/2009. So its index ratio on 10/22/2018 is
    1.17420 = 252.10084 / 214.69971

Edited 10/22/18 1:15 PM to fix two typos in footnote 2.
Last edited by #Cruncher on Mon Oct 22, 2018 12:16 pm, edited 1 time in total.

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Re: Thoughts on 5 year TIPS bonds?

Post by Valuethinker » Sun Oct 21, 2018 7:40 am

BlueEars wrote:
Fri Oct 19, 2018 6:47 pm
Every once in awhile lately I mull buying some 5 year TIPS in retirement accounts. Maybe 10% of our FI to start with. 5 year TIPS because we are retired at age 70 and can easily hold to maturity. The current rates are starting to look tempting. Should I be tempted?

The current rate is 1.07%. Here is the bigger historical picture:

Image
Given all the risks out there 1 per cent real, guaranteed for 5 years sounds pretty attractive to me. If real interest rates spike then you are holding to maturity anyways you should not experience a capital loss.

Your only risk is reinvestment of the coupons if yields fall. OR opportunity cost of tieing up your money if real rates rise OR deflation risk if prices fall.

All of these are I think bearable over a 5 year term.

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Sun Oct 21, 2018 9:34 am

#Cruncher wrote:
Sun Oct 21, 2018 7:31 am
For TIPS maturing in the near future, the market estimates what these will be on the maturity date. It then adjusts today's price so that the nominal yield (i.e., the yield after adjusting for inflation) will be comparable to the yield on nominal Treasury securities maturing at the same time.
...
The 1.17565 estimated index ratio on 1/15/2019 is 0.12% higher than the 1.17420 on 10/22/2018. But it is actually a touch less than the 1.17578 on 12/1/2018 -- the latest date for which index ratios are currently known. This means the market is expecting the monthly CPIs to be reported for October and November (the two months used to calculated the Reference CPI for 1/15/2019) to be (on average) about the same as the September CPI (which is the Reference CPI for 12/1/2019).
To be sure I understand, the market is expecting a net of ~0% inflation to be reported for October and November, based on that TIPS price. Seems unlikely to me, but what do I know :?:

I suppose along with seasonality, a factor is that inflation protection for 2-3 months is not worth a whole lot and there is also some chance of deflation over a short time frame like that? I think the accrued principal above 1000 is at risk in deflation and so the 1174 could, theoretically, decline to as low as 1000?
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Re: Thoughts on 5 year TIPS bonds?

Post by Sammy_M » Sun Oct 21, 2018 9:45 am

The improvement in short term TIPS yields has me thinking of redeeming my 0% real I-Bonds (2011, 2012 and 2016) and investing the proceeds into Vanguard Short-Term Inflation-Protected Securities Index Fund. How would one properly evaluate that decision? I know there is a near-term tax bill and you forever lose the tax deferred "space".

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Sun Oct 21, 2018 10:20 am

Thanks for all the interesting thoughts so far.

When I look at the Fed Funds rate versus 5 year TIPS (see below), it makes me think that maybe buying 2 year TIPS as mentioned above is perhaps a decent strategy. Should we get a continuation up in the Fed Funds rate, it might be possible to get 5 year TIPS at even better rates 2 years hence.

Image

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Sun Oct 21, 2018 3:47 pm

Sammy_M wrote:
Sun Oct 21, 2018 9:45 am
The improvement in short term TIPS yields has me thinking of redeeming my 0% real I-Bonds (2011, 2012 and 2016) and investing the proceeds into Vanguard Short-Term Inflation-Protected Securities Index Fund. How would one properly evaluate that decision? I know there is a near-term tax bill and you forever lose the tax deferred "space".
I, too, need to decide whether or not to keep some 0% I-bonds. Since ours are all more than 5 years old, I had been thinking that they now act like a saving account and 2.3% or so, with state tax exemption for that is still okay. The current yield is also comparable to 13 week T-bills.

If I were considering cashing them in and buying VTAPX, I would look at it like this:
Gains are about 10% and tax rate is 12%, so cashing $1000 would leave me with $988 to invest. If invested in VTAPX, I would only need to earn about an extra 1.2% to make up for the $12 tax bill. Seem like that would occur in 1-2 years?

After that, if I am getting, say, 1% real, rather than 0% then inflation would have to be above 7.33% for the I-bonds to come out ahead:
$1000 at 8.33% total return and 12% income tax, leaves me with $73.30.
$1000 at 7.33% total return and no income tax, leaves me with $73.30.
Therefore I would just break even, even if I never paid income tax on the 0% I-bonds. That's not going to happen so inflation would need to be even higher for I-bonds to win.

So at current rates it seems like it would make sense for me to move from I-bonds to VTAPX (or just buy some short term TIPS).
press on, regardless - John C. Bogle

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Re: Thoughts on 5 year TIPS bonds?

Post by Valuethinker » Sun Oct 21, 2018 4:09 pm

BlueEars wrote:
Sun Oct 21, 2018 10:20 am
Thanks for all the interesting thoughts so far.

When I look at the Fed Funds rate versus 5 year TIPS (see below), it makes me think that maybe buying 2 year TIPS as mentioned above is perhaps a decent strategy. Should we get a continuation up in the Fed Funds rate, it might be possible to get 5 year TIPS at even better rates 2 years hence.

Image
I don't think you can read these things off charts. If the US slips into recession, real yields could be lower in 2 years time.

I would tend to buy the 5 year TIPS because then it is done and dusted. Unless there's a big swing in real yields, I wouldn't feel too stupid about it.

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Sun Oct 21, 2018 4:13 pm

Valuethinker wrote:
Sun Oct 21, 2018 4:09 pm
...

I don't think you can read these things off charts. If the US slips into recession, real yields could be lower in 2 years time.

I would tend to buy the 5 year TIPS because then it is done and dusted. Unless there's a big swing in real yields, I wouldn't feel too stupid about it.
Actually I was thinking of averaging into this. Maybe 50% of position now and then 25% in 6 months, 25% again in 1 year. That way I wouldn't feel too bad if we went up to 2% real in the next year or so.

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Re: Thoughts on 5 year TIPS bonds?

Post by Noobvestor » Sun Oct 21, 2018 9:36 pm

Sammy_M wrote:
Sun Oct 21, 2018 9:45 am
The improvement in short term TIPS yields has me thinking of redeeming my 0% real I-Bonds (2011, 2012 and 2016) and investing the proceeds into Vanguard Short-Term Inflation-Protected Securities Index Fund. How would one properly evaluate that decision? I know there is a near-term tax bill and you forever lose the tax deferred "space".
One factor worth considering is whether you'll have any low-income years in the future. For instance, I expect to have some low/no-income years before I reach retirement age, meaning I'll be able to cash out I Bonds tax-free potentially. Part of the value of I Bonds (to me, at least) is the ability to cash them out at any point along the way, and to optimize that cash-out for tax purposes (beyond just tax deferral).
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Re: Thoughts on 5 year TIPS bonds?

Post by saves nine » Sun Oct 21, 2018 10:36 pm

Have you considered Vanguard's short term inflation indexed etf or fund, VTIP or VTAPX?

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Re: Thoughts on 5 year TIPS bonds?

Post by Valuethinker » Mon Oct 22, 2018 2:43 am

BlueEars wrote:
Sun Oct 21, 2018 4:13 pm
Valuethinker wrote:
Sun Oct 21, 2018 4:09 pm
...

I don't think you can read these things off charts. If the US slips into recession, real yields could be lower in 2 years time.

I would tend to buy the 5 year TIPS because then it is done and dusted. Unless there's a big swing in real yields, I wouldn't feel too stupid about it.
Actually I was thinking of averaging into this. Maybe 50% of position now and then 25% in 6 months, 25% again in 1 year. That way I wouldn't feel too bad if we went up to 2% real in the next year or so.
"Minimize regret" is an excellent strategy -- well justified in economic theory (and psychology).

But I would go for the 5 year, unless you will need the money sooner. If things follow their normal course, as the Fed tightens *all* interest rates rise, including TIPS yields.

Why then would I be tempted by 5 year bonds? Because the UK has negative rates on its inflation linked bonds. If the market gets worried about inflation the price of these things will rise - yields fall.

Thus a situation where no real yield at all is available is possible. US TIPS are in short supply relative to the potential demand for safe inflation linked assets. (US pension funds are much less likely to be CPI indexed; however the problem of rising obligations due to rising wage rates remains for DB schemes).

You are risking higher volatility by moving out along the yield curve (time to maturity for TIPS bonds - real yield curve rather than nominal) but you are also (except for reinvestment of coupons) "locking in" a real yield.

Maybe we go back to 2.5% real yields on TIPS. Maybe. I could also make a case for 0% (or below).

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Re: Thoughts on 5 year TIPS bonds?

Post by JackoC » Mon Oct 22, 2018 9:30 am

jeffyscott wrote:
Sun Oct 21, 2018 9:34 am
#Cruncher wrote:
Sun Oct 21, 2018 7:31 am
For TIPS maturing in the near future, the market estimates what these will be on the maturity date. It then adjusts today's price so that the nominal yield (i.e., the yield after adjusting for inflation) will be comparable to the yield on nominal Treasury securities maturing at the same time.
...
The 1.17565 estimated index ratio on 1/15/2019 is 0.12% higher than the 1.17420 on 10/22/2018. But it is actually a touch less than the 1.17578 on 12/1/2018 -- the latest date for which index ratios are currently known. This means the market is expecting the monthly CPIs to be reported for October and November (the two months used to calculated the Reference CPI for 1/15/2019) to be (on average) about the same as the September CPI (which is the Reference CPI for 12/1/2019).
To be sure I understand, the market is expecting a net of ~0% inflation to be reported for October and November, based on that TIPS price. Seems unlikely to me, but what do I know :?:

I suppose along with seasonality...
It seems to be mainly the seasonality. Every year since 2011 the absolute reading on the CPI, non-seasonally adjusted, has been lower in November than September. For example in 2017 it was 216.819 in Sep, 216.669 in Nov. Even though the whole year % increase varied between nearly 0 (2015) and 3+ (2011) in that period.

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Mon Oct 22, 2018 9:45 am

JackoC wrote:
Mon Oct 22, 2018 9:30 am
jeffyscott wrote:
Sun Oct 21, 2018 9:34 am
#Cruncher wrote:
Sun Oct 21, 2018 7:31 am
For TIPS maturing in the near future, the market estimates what these will be on the maturity date. It then adjusts today's price so that the nominal yield (i.e., the yield after adjusting for inflation) will be comparable to the yield on nominal Treasury securities maturing at the same time.
...
The 1.17565 estimated index ratio on 1/15/2019 is 0.12% higher than the 1.17420 on 10/22/2018. But it is actually a touch less than the 1.17578 on 12/1/2018 -- the latest date for which index ratios are currently known. This means the market is expecting the monthly CPIs to be reported for October and November (the two months used to calculated the Reference CPI for 1/15/2019) to be (on average) about the same as the September CPI (which is the Reference CPI for 12/1/2019).
To be sure I understand, the market is expecting a net of ~0% inflation to be reported for October and November, based on that TIPS price. Seems unlikely to me, but what do I know :?:

I suppose along with seasonality...
It seems to be mainly the seasonality. Every year since 2011 the absolute reading on the CPI, non-seasonally adjusted, has been lower in November than September. For example in 2017 it was 216.819 in Sep, 216.669 in Nov. Even though the whole year % increase varied between nearly 0 (2015) and 3+ (2011) in that period.
Maybe BLS does a lot of shopping on black Friday, cyber Monday, etc. :)
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Re: Thoughts on 5 year TIPS bonds?

Post by Valuethinker » Mon Oct 22, 2018 11:42 am

jeffyscott wrote:
Mon Oct 22, 2018 9:45 am
JackoC wrote:
Mon Oct 22, 2018 9:30 am
jeffyscott wrote:
Sun Oct 21, 2018 9:34 am
#Cruncher wrote:
Sun Oct 21, 2018 7:31 am
For TIPS maturing in the near future, the market estimates what these will be on the maturity date. It then adjusts today's price so that the nominal yield (i.e., the yield after adjusting for inflation) will be comparable to the yield on nominal Treasury securities maturing at the same time.
...
The 1.17565 estimated index ratio on 1/15/2019 is 0.12% higher than the 1.17420 on 10/22/2018. But it is actually a touch less than the 1.17578 on 12/1/2018 -- the latest date for which index ratios are currently known. This means the market is expecting the monthly CPIs to be reported for October and November (the two months used to calculated the Reference CPI for 1/15/2019) to be (on average) about the same as the September CPI (which is the Reference CPI for 12/1/2019).
To be sure I understand, the market is expecting a net of ~0% inflation to be reported for October and November, based on that TIPS price. Seems unlikely to me, but what do I know :?:

I suppose along with seasonality...
It seems to be mainly the seasonality. Every year since 2011 the absolute reading on the CPI, non-seasonally adjusted, has been lower in November than September. For example in 2017 it was 216.819 in Sep, 216.669 in Nov. Even though the whole year % increase varied between nearly 0 (2015) and 3+ (2011) in that period.
Maybe BLS does a lot of shopping on black Friday, cyber Monday, etc. :)
The effect is well known from a commercial viewpoint.

Q4 is the best quarter for almost all of retail (except The Home Depot etc. perhaps).

They thus price the merchandise at full price at the start of the quarter (September and October, in effect).

That gives them room to cut prices. In addition, in most legal jurisdictions I believe to advertise a product at "x% off" the law requires them to first genuinely have it on sale at the higher price. To mark it down it genuinely has to have been originally at the higher price.

With the increased dominance of Black Friday, they have to slash prices further in November. Thus it pays them to have a higher price in September to cut from ... to ...

It may be the BLS does not fully capture that effect.

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Mon Oct 22, 2018 11:58 am

Valuethinker wrote:
Mon Oct 22, 2018 2:43 am
BlueEars wrote:
Sun Oct 21, 2018 4:13 pm
Valuethinker wrote:
Sun Oct 21, 2018 4:09 pm
...

I don't think you can read these things off charts. If the US slips into recession, real yields could be lower in 2 years time.

I would tend to buy the 5 year TIPS because then it is done and dusted. Unless there's a big swing in real yields, I wouldn't feel too stupid about it.
Actually I was thinking of averaging into this. Maybe 50% of position now and then 25% in 6 months, 25% again in 1 year. That way I wouldn't feel too bad if we went up to 2% real in the next year or so.
"Minimize regret" is an excellent strategy -- well justified in economic theory (and psychology).

But I would go for the 5 year, unless you will need the money sooner. If things follow their normal course, as the Fed tightens *all* interest rates rise, including TIPS yields.

Why then would I be tempted by 5 year bonds? Because the UK has negative rates on its inflation linked bonds. If the market gets worried about inflation the price of these things will rise - yields fall.

Thus a situation where no real yield at all is available is possible. US TIPS are in short supply relative to the potential demand for safe inflation linked assets. (US pension funds are much less likely to be CPI indexed; however the problem of rising obligations due to rising wage rates remains for DB schemes).

You are risking higher volatility by moving out along the yield curve (time to maturity for TIPS bonds - real yield curve rather than nominal) but you are also (except for reinvestment of coupons) "locking in" a real yield.

Maybe we go back to 2.5% real yields on TIPS. Maybe. I could also make a case for 0% (or below).
Valuethinker, I like your reasoning. Better in my circumstances to take a pretty full position when rates are favorable then to wait and hope for better. I would hate to see the opportunity slip away if rates slide somewhat from here ... another kind of regret.

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Re: Thoughts on 5 year TIPS bonds?

Post by JackoC » Mon Oct 22, 2018 2:48 pm

Valuethinker wrote:
Mon Oct 22, 2018 11:42 am
jeffyscott wrote:
Mon Oct 22, 2018 9:45 am
JackoC wrote:
Mon Oct 22, 2018 9:30 am
jeffyscott wrote:
Sun Oct 21, 2018 9:34 am
#Cruncher wrote:
Sun Oct 21, 2018 7:31 am
This means the market is expecting the monthly CPIs to be reported for October and November (the two months used to calculated the Reference CPI for 1/15/2019) to be (on average) about the same as the September CPI (which is the Reference CPI for 12/1/2019).
To be sure I understand, the market is expecting a net of ~0% inflation to be reported for October and November, based on that TIPS price. Seems unlikely to me, but what do I know :?:
Every year since 2011 the absolute reading on the CPI, non-seasonally adjusted, has been lower in November than September. For example in 2017 it was 216.819 in Sep, 216.669 in Nov. Even though the whole year % increase varied between nearly 0 (2015) and 3+ (2011) in that period.
Maybe BLS does a lot of shopping on black Friday, cyber Monday, etc. :)
The effect is well known from a commercial viewpoint.

It may be the BLS does not fully capture that effect.
Just to reiterate as Cruncher also noted before, TIPS index values are calculated on *non* seasonally adjusted values of the CPI. IOW they aren't trying to correct for any seasonal factor.

An interesting corollary is that realized real rates on nominal short term instruments (like T-bills) can show a pronounced seasonality unless bill rates go up and down seasonally. Right now the 3 mo T-bill yields around 2.3% and the market apparently expects its real return to be almost that much. But if inflation is generally running around 2.something %, 3 mo bills at 2.3% must be real return losers in other quarters. Research in other countries with higher inflation with strong seasonal variation has shown that several month nominal rates can also become seasonal, even if they don't exactly match the central statistics bureau's measure of seasonality. One countervailing factor is that central banks often target a ~zero maturity rate at a given nominal value, so in effect monetary policy tightness is seasonal, but nominal rates even out several months will be less seasonal. But real return on them is still seasonal if realized inflation is varying seasonally.

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Mon Nov 05, 2018 5:46 pm

Follow up: I bought TIPS April 2023 at about 1.05%. Will hold to maturity. This is now 22% of my FI.

I'm looking at buying some very short term TIPS. Some quotes from today:

April 2019 2.1% <<<<<< might purchase these and extend out later if real rates continue to go up
April 2020 1.3%
April 2021 1.2%
April 2022 1.2%
April 2023 1.1%

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Re: Thoughts on 5 year TIPS bonds?

Post by Kevin M » Mon Nov 05, 2018 7:08 pm

There has been some mention of the seasonality effect. #Cruncher developed a spreadsheet to derive an estimated real yield that factors in seasonality. I made some modifications, for example, to dynamically pull CPI data from FRED, and to use quotes downloaded from Fidelity. Below is a chart showing the stated ask yield and the estimated yield adjusted for the seasonality effect for maturities out to 5.2 years (using quotes just pulled from Fidelity).

Image

It's about as flat as you can get starting with the TIPS maturing 4/15/2019 (0.44-year maturity).

I'm thinking that if things are similar as CDs or Treasuries mature in my IRAs, I'll use the proceeds to start adding some TIPS in the 1-year to 2-year maturity range to my IRA fixed income.

Kevin
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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Mon Nov 05, 2018 8:03 pm

So Kevin, if I understand you right the real yield as stated on the April 2019 is an illusion. When I run the VG quotes I have to correct them? When the inflation is corrected for seasonality it brings the real yield in line with the yields further out? The correction appears to be much less for dates out over 5 years.

I don't understand the calculation but the conclusion is important to me. So I'm not getting a bargain on the April 2019 and might as well go further out to April 2020. Sound right?

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Re: Thoughts on 5 year TIPS bonds?

Post by Kevin M » Mon Nov 05, 2018 8:39 pm

BlueEars wrote:
Mon Nov 05, 2018 8:03 pm
So Kevin, if I understand you right the real yield as stated on the April 2019 is an illusion. When I run the VG quotes I have to correct them? When the inflation is corrected for seasonality it brings the real yield in line with the yields further out?
Based on my understanding from what I've learned from #Cruncher, yes. For the 4/2019 TIPS, there also may be some of effect of short-term TIPS being priced to be competitive with short-term nominal Treasuries. Given the much higher yield, I would guess so, but #Cruncher's seasonal adjustment brings it in line with the longer-term TIPS, so maybe not. I'll let #Cruncher enlighten us on this.
The correction appears to be much less for dates out over 5 years.
Yes, the seasonality effects diminish with increasing maturity. I didn't show charts for 10 years and 30 years, but looking at them demonstrates this even more clearly.
I don't understand the calculation but the conclusion is important to me. So I'm not getting a bargain on the April 2019 and might as well go further out to April 2020. Sound right?
Although I can work through the calculations in the spreadsheet, I haven't yet developed an intuitive understanding of it so that I can articulate it in a way that I could understand it if explaining it to myself.
:oops:

If we assume that the TIPS market is reasonably efficient, then there should be no particularly good deals for a particular maturity. So, what #Cruncher's calculations show seems to be consistent with the notion of an efficient TIPS market.

If we trust this, then there would be nothing wrong with a TIPS ladder that included both the 4/2019 and 4/2020 TIPS. It should just depend on the shortest rung you wanted in your ladder. There also would be nothing wrong with including TIPS that mature in months other than April, even though they have lower quoted (non-adjusted) yields.

Kevin
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Re: Thoughts on 5 year TIPS bonds?

Post by protagonist » Mon Nov 05, 2018 9:14 pm

For those in retirement, who treat fixed income as a means of wealth preservation (rather than seeking maximum growth which comes with associated risk), and who can comfortably afford to tie up savings for 5 years, why would a guarantee of beating inflation by 1% over 5 years in a tax-deferred account ever NOT be a good idea (even if other vehicles might ultimately be more profitable)?

The funds you are willing to risk are in equities.

Those that you want to protect would grow by 1% in real terms, meaning you will have more 5 years from now in real terms than you have today, regardless of inflation or deflation or changes in interest rates. No CD or bond investment will give you that security, and isn't what fixed income is all about? Security? Otherwise we would all be 100% in stocks.

I also don't understand why people make an issue of "reinvestment risk", since whatever you are invested in, 5 years later, how that translates regarding your prospects in real terms will be determined by the investment climate going forward. There is nothing special I see about TIPS in that regard, other than the fact that you know they will be worth more in real terms in 5 years, which you don't know about your stocks or bonds or CDs.

I don't own TIPS and don't have liquid cash to invest in TIPS currently. But please tell me what I am missing here because I would like to understand the controversy.

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Re: Thoughts on 5 year TIPS bonds?

Post by BlueEars » Mon Nov 05, 2018 9:38 pm

Protagonist I agree that 5 year money TIPS are a great choice in retirement. Even though historical real rates have been better then 1% these rates are a decent certainty.

But a retiree needs to think about their spending requirements for each year going forward. In my case I have to take RMD's each year that are substantial so 5 year TIPS won't satisfy that requirement. It's very individual based on spending choices and income streams (IRA's, Roths, taxable, maybe pensions, etc.). Kind of complicated. Also one's investment in stocks can impact this as rebalance choices can effect the FI component. So I would want some quick liquidity. I experienced that rebalance issue in 2009.

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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Mon Nov 05, 2018 10:21 pm

Kevin M wrote:
Mon Nov 05, 2018 7:08 pm
There has been some mention of the seasonality effect. #Cruncher developed a spreadsheet to derive an estimated real yield that factors in seasonality. I made some modifications, for example, to dynamically pull CPI data from FRED, and to use quotes downloaded from Fidelity. Below is a chart showing the stated ask yield and the estimated yield adjusted for the seasonality effect for maturities out to 5.2 years (using quotes just pulled from Fidelity).

Image

It's about as flat as you can get starting with the TIPS maturing 4/15/2019 (0.44-year maturity).

I'm thinking that if things are similar as CDs or Treasuries mature in my IRAs, I'll use the proceeds to start adding some TIPS in the 1-year to 2-year maturity range to my IRA fixed income.

Kevin
Since I am considering just using VTAPX to start getting back into TIPS, it's good to know that they all actually have the same adjusted expected real return, right at 1%. The only exception being the earliest maturing one, which would seem to be Jan 15, 2019 and that one is only 2.69% of the fund.
press on, regardless - John C. Bogle

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Re: Thoughts on 5 year TIPS bonds?

Post by willthrill81 » Mon Nov 05, 2018 10:24 pm

protagonist wrote:
Mon Nov 05, 2018 9:14 pm
For those in retirement, who treat fixed income as a means of wealth preservation (rather than seeking maximum growth which comes with associated risk), and who can comfortably afford to tie up savings for 5 years, why would a guarantee of beating inflation by 1% over 5 years in a tax-deferred account ever NOT be a good idea (even if other vehicles might ultimately be more profitable)?

The funds you are willing to risk are in equities.

Those that you want to protect would grow by 1% in real terms, meaning you will have more 5 years from now in real terms than you have today, regardless of inflation or deflation or changes in interest rates. No CD or bond investment will give you that security, and isn't what fixed income is all about? Security? Otherwise we would all be 100% in stocks.

I also don't understand why people make an issue of "reinvestment risk", since whatever you are invested in, 5 years later, how that translates regarding your prospects in real terms will be determined by the investment climate going forward. There is nothing special I see about TIPS in that regard, other than the fact that you know they will be worth more in real terms in 5 years, which you don't know about your stocks or bonds or CDs.

I don't own TIPS and don't have liquid cash to invest in TIPS currently. But please tell me what I am missing here because I would like to understand the controversy.
While I don't currently have any fixed income aside from some of my EF, I'm inclined to agree. In retirement, I would certainly be willing to go in for some five year TIPS at 1% real. At 2-3% real, I'd start backing up the truck.
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Re: Thoughts on 5 year TIPS bonds?

Post by jeffyscott » Tue Nov 06, 2018 7:33 am

protagonist wrote:
Mon Nov 05, 2018 9:14 pm
For those in retirement, who treat fixed income as a means of wealth preservation (rather than seeking maximum growth which comes with associated risk), and who can comfortably afford to tie up savings for 5 years, why would a guarantee of beating inflation by 1% over 5 years in a tax-deferred account ever NOT be a good idea (even if other vehicles might ultimately be more profitable)?

The funds you are willing to risk are in equities.

Those that you want to protect would grow by 1% in real terms, meaning you will have more 5 years from now in real terms than you have today, regardless of inflation or deflation or changes in interest rates. No CD or bond investment will give you that security, and isn't what fixed income is all about? Security? Otherwise we would all be 100% in stocks.
I get my security from a pension but the thing is, you could change "1% real" to 0.5% real or 0.1% real in your statement and make the same argument that no CD or bond investment will give you that security.
press on, regardless - John C. Bogle

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Re: Thoughts on 5 year TIPS bonds?

Post by protagonist » Tue Nov 06, 2018 11:44 am

jeffyscott wrote:
Tue Nov 06, 2018 7:33 am
protagonist wrote:
Mon Nov 05, 2018 9:14 pm
For those in retirement, who treat fixed income as a means of wealth preservation (rather than seeking maximum growth which comes with associated risk), and who can comfortably afford to tie up savings for 5 years, why would a guarantee of beating inflation by 1% over 5 years in a tax-deferred account ever NOT be a good idea (even if other vehicles might ultimately be more profitable)?

The funds you are willing to risk are in equities.

Those that you want to protect would grow by 1% in real terms, meaning you will have more 5 years from now in real terms than you have today, regardless of inflation or deflation or changes in interest rates. No CD or bond investment will give you that security, and isn't what fixed income is all about? Security? Otherwise we would all be 100% in stocks.
I get my security from a pension but the thing is, you could change "1% real" to 0.5% real or 0.1% real in your statement and make the same argument that no CD or bond investment will give you that security.
Exactly, which is why I buy I-bonds every year. I'm 66. About half of my portfolio is in stocks (index funds). I hope I make a lot of money, but, like if I went to the casino, I only gamble with what I can afford to lose, and I could accept losing it all. I view the other half as a cushion that will keep me afloat if the stock market suffers a huge crash and does not recover during my lifetime. That is a real possibility, and whereas I don't think it will probably happen, nobody really knows its probability. If I make money with fixed income, wonderful. But that is not the objective, and it doesn't make sense to trade risk for potential reward with that money if I don't need to do so. That is what stocks are for...at least the way I interpret things.
Last edited by protagonist on Tue Nov 06, 2018 11:53 am, edited 1 time in total.

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Re: Thoughts on 5 year TIPS bonds?

Post by protagonist » Tue Nov 06, 2018 11:50 am

BlueEars wrote:
Mon Nov 05, 2018 9:38 pm
Protagonist I agree that 5 year money TIPS are a great choice in retirement. Even though historical real rates have been better then 1% these rates are a decent certainty.

But a retiree needs to think about their spending requirements for each year going forward. In my case I have to take RMD's each year that are substantial so 5 year TIPS won't satisfy that requirement. It's very individual based on spending choices and income streams (IRA's, Roths, taxable, maybe pensions, etc.). Kind of complicated. Also one's investment in stocks can impact this as rebalance choices can effect the FI component. So I would want some quick liquidity. I experienced that rebalance issue in 2009.
The need for liquidity makes sense to me. I would not want to invest more in 5 year TIPS than I was sure I would not need for 5 years. You would not want to have to tap into your TIPS for your RMDs .

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Re: Thoughts on 5 year TIPS bonds?

Post by Kevin M » Tue Nov 06, 2018 12:08 pm

BlueEars wrote:
Mon Nov 05, 2018 9:38 pm
But a retiree needs to think about their spending requirements for each year going forward. In my case I have to take RMD's each year that are substantial so 5 year TIPS won't satisfy that requirement. It's very individual based on spending choices and income streams (IRA's, Roths, taxable, maybe pensions, etc.). Kind of complicated. Also one's investment in stocks can impact this as rebalance choices can effect the FI component. So I would want some quick liquidity. I experienced that rebalance issue in 2009.
That's why some people use TIPS ladders. Given that you earn about the same on a 1-year TIPS as a 5-year TIPS, a 5-year TIPS ladder would be a reasonable way to cover your RMDs or other IRA distributions over the next five years.

Of course the objective of a liability-matching TIPS ladder is not to cover RMDs, but residual living expenses (not covered by SS, pensions, etc.). So when you take your RMD, you might put whatever you don't spend that year into I Bonds, a TIPS fund (unless you don't mind the hassles of tax reporting with TIPS), or perhaps even some short-term nominal fixed income.

Or, if you have stocks in IRAs, swap some stocks in the IRA for more TIPS, and buy stocks with the excess RMDs in taxable.

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