Buy TIPS Mutual Fund or I-Bonds?

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diyinvestor
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Buy TIPS Mutual Fund or I-Bonds?

Post by diyinvestor »

I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?

Thanks, everyone.
SciurusVulgaris
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by SciurusVulgaris »

Check out the wiki for some info:

https://www.bogleheads.org/wiki/I_Bonds_vs_TIPS

I look at it this way. TIPS have issues in taxable. I-Bonds have relatively low limits. Treasuries are good, but may not be good for taxable. ST Corporate bonds have a higher yield but more risk.

For me, I choose I-Bonds in taxable for part of my emergency fund. I keep the Total Bond Market index in tax deferred. There are nuances, you'll need to do your own research.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Day9 »

Those are all fine choices. So are CDs and Total Bond Index Fund. To get a better idea we need to know more. Are these bonds going in your retirement portfolio? What % of your retirement portfolio is in stocks, and what % in bonds? The more information we have the better we can answer. But to be honest all listed options are good (so long as your short-term corporates are investment grade) and you can't really go wrong with any of these choices.

Just please do not reach for yield by replacing safe bonds with junk bonds, emerging market bonds, high divided yield stocks, convertible notes, etc. The solution to low bond yields is to save more and work longer. That is the true answer that no one wants to hear.
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FIREchief
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by FIREchief »

Day9 wrote: Mon Aug 10, 2020 3:44 pm Just please do not reach for yield by replacing safe bonds with junk bonds, emerging market bonds, high divided yield stocks, convertible notes, etc. The solution to low bond yields is to save more and work longer. That is the true answer that no one wants to hear.
+1. The other advice often given here is that if a person does feel compelled to increase risk for greater returns, shifting AA slightly more towards stocks is a better idea than buying junk.
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RomeoMustDie
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by RomeoMustDie »

In my opinion, anything outside of short duration treasuries takes way too much active management in the current economic climate.
Nahtanoj
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Nahtanoj »

iBonds have some advantages right now compared to TIPS and conventional Treasuries:

* the interest rate is 0% after inflation, while the interest rate on TIPS and Treasuries is currently negative after inflation
* the price at which you can sell the iBonds is fixed, so they won’t go down in value if interest rates go up (of course, they won’t go up in value if interest rates go down, either)
* they are tax deferred, unlike TIPS and Treasuries (unless you hold the TIPS and Treasuries in a retirement account)
Buffetologist
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Buffetologist »

Because of the eventual taxes due on the inflation adjustments, I-bonds always have a negative real rate too unless you are eligible to use them for education. I hold TIPS in my retirement account. I understand there is currently a significant negative real yield. There is no way that I know of to hold I-bonds in a retirement account. I don't know of a way to get low volatility inflation protection that has a positive real-yield after taxes.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by jeffyscott »

Buffetologist wrote: Tue Aug 11, 2020 5:18 amBecause of the eventual taxes due on the inflation adjustments, I-bonds always have a negative real rate too unless you are eligible to use them for education. I hold TIPS in my retirement account. I understand there is currently a significant negative real yield. There is no way that I know of to hold I-bonds in a retirement account. I don't know of a way to get low volatility inflation protection that has a positive real-yield after taxes.
There is the retirement account issue for I-bonds, but while both TIPS and I-bonds may have negative real yields after taxes, I-bonds still have a higher yield. Taxes are deferred on I-bonds gains, but they can be bought only with after tax money, unlike the TIPS in a retirement account. If one is filling all retirement accounts and has additional taxable savings, then it may be a choice between I-bonds or stocks in taxable...so in that case it becomes a choice between I-bonds in taxable (which is actually then tax-deferred for the gains) with stocks in tax-deferred vs. TIPS in tax-deferred with stocks in taxable.

Based on TIPS and nominal treasury rates, expected inflation is about 1.5% over the next 5 years. With some effort, you may find 5 year direct CDs at about that rate or better (1.55% is currently available to me) for IRA money. But like I-bonds, those "high" rate direct CDs are also not available in an employer account.
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JackoC
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by JackoC »

diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious. Only doable up to the purchase limit for I-Bonds obviously, but while that's not enough for I-Bonds to be the 'solution' for many investors, there aren't that many investors where $10k per person/yr is a totally negligible amount either.

Assuming no direct inflation protection (whether or how much of that you need is a risk preference issue) but US govt risk, best yielding direct CD's yield far more than US treasuries, a much wider spread now than has generally prevailed. Only money which requires absolute total minute to minute liquidity should be put in cash nominal treasuries now IMO. Even if using bonds to 'rebalance' into stocks when they decline (which is not the only way to do it), that's highly unlikely to be a large % one's fixed income allocation. There could be an argument for long treasuries because of their price interaction with stocks, but now the spread of 'best CD' curve over treasuries is so large that's also hard to justify IMO (and again can be done another way: put most of the actual cash to work in CD's at perhaps near 1.5%, or even nearly 2% in truly exceptional cases, over the treasury curve, then go short medium term treasury note futures to hedge out the CD duration, and long (long) bond futures if you really think high duration is the special sauce correlation-wise v equities, I don't bother with that myself). As mentioned and obviously, subject to being able to put the money in direct CD's at absolute best rates; limited to brokered CD's offered by one particular provider it's not nearly as attractive right now.

Credit-risky bonds are a preference issue with no objective answer. But I don't think investment grade corporate bond index investing is worthwhile personally. There were historically drags on return from the indexing process, like the index getting rid of short maturity bonds (but corporates have historically tended to have better risk return between short maturity and zero maturity) and selling out bonds at a loss when downgraded below Baa (Ba range tended to have highest return for risk among corporate bonds historically). Neither as big an issue if it's a short term corp fund though. But the relatively small credit risk you're taking is fairly closely correlated with equity risk, so why not just take a little more equity risk instead?
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Blue456 »

diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?

Thanks, everyone.
I bonds seem to be the best deal right now. We are in the process of converting from Ally to Treasury Direct.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Buffetologist »

JackoC wrote: Tue Aug 11, 2020 9:23 am
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious.
Maybe I'm an idiot, but can you work this obviousness out comparing TIPS in retirement to I-Bond in taxable. It's not obvious to me. I wouldn't hold TIPS in taxable for the same reason I don't hold I-bonds - the taxes make them a guaranteed loser with respect to inflation. I haven't seen anybody adequately address the fact that for I-bonds because all of your gain is taxable interest, then the real return is guaranteed to be negative.

While TIPS currently have a negative real yield, which is unfortunate, that's a recent phenomena. We are trying to figure out if
Ibonds [0% plus inflation*(1-taxes)] will outperform TIPS in a retirement account [-1.25% + inflation}.

For Ibonds to be the winner, inflation*taxes must be less than 1.25%. This certainly depends on the value of inflation with the benefit swinging wildly to TIPS as inflation increases. Why is this wrong?
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by alluringreality »

Buffetologist wrote: Tue Aug 11, 2020 12:51 pm For Ibonds to be the winner, inflation*taxes must be less than 1.25%. This certainly depends on the value of inflation with the benefit swinging wildly to TIPS as inflation increases. Why is this wrong?
That's generally the way that I compare I Bonds against TIPS in Roth. One additional benefit to I Bonds could be deflationary periods. Over 6 month periods I Bonds can have a zero nominal return during deflation, which has happened in the past, and TIPS principal would decline during deflation. TIPS only are protected against deflation over the entire term, where you're guaranteed to receive the original principal. If I wanted to make room for Roth to buy TIPS I'd probably move stocks to taxable, and my state taxes capital gains, so that comes into play with my own comparison. I'm in low tax brackets and don't really expect some of the higher historical inflation rates, so I doubt that current TIPS rates are likely to benefit me, but high inflation and federal taxes could favor TIPS in Roth.
Last edited by alluringreality on Tue Aug 11, 2020 1:57 pm, edited 2 times in total.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Nowizard »

Keep in mind that TIPs are recommended at this time related to possibility of inflation, something that has not occurred for quite a few years. When making stock changes based on the market at a given point in time and predicting another point in time, it is called market timing. How does the recommendation for TIPs during a time of low bond yields differ? As the poster said, bonds are confusing, and this is one question I cannot answer, among others.

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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by FIREchief »

Nowizard wrote: Tue Aug 11, 2020 1:36 pm Keep in mind that TIPs are recommended at this time related to possibility of inflation, something that has not occurred for quite a few years.
We've certainly have had inflation, and it has exceeded expectations quite often (thus rewarding the TIPS buyer vs. the nominal US Treasury buyer during those periods). #crucher posted a detailed chart in a related thread a few days ago. :sharebeer
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Walkure »

Buffetologist wrote: Tue Aug 11, 2020 12:51 pm
JackoC wrote: Tue Aug 11, 2020 9:23 am
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious.
Maybe I'm an idiot, but can you work this obviousness out comparing TIPS in retirement to I-Bond in taxable. It's not obvious to me. I wouldn't hold TIPS in taxable for the same reason I don't hold I-bonds - the taxes make them a guaranteed loser with respect to inflation. I haven't seen anybody adequately address the fact that for I-bonds because all of your gain is taxable interest, then the real return is guaranteed to be negative.

While TIPS currently have a negative real yield, which is unfortunate, that's a recent phenomena. We are trying to figure out if
Ibonds [0% plus inflation*(1-taxes)] will outperform TIPS in a retirement account [-1.25% + inflation}.

For Ibonds to be the winner, inflation*taxes must be less than 1.25%. This certainly depends on the value of inflation with the benefit swinging wildly to TIPS as inflation increases. Why is this wrong?
I believe the comparison accounts for the fact that holding I-bonds instead of TIPS frees up retirement space for other assets, so the deferred taxes on I-bonds are being offset by the stocks that can be shifted out of taxable.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by jeffyscott »

Buffetologist wrote: Tue Aug 11, 2020 12:51 pm
JackoC wrote: Tue Aug 11, 2020 9:23 am
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious.
Maybe I'm an idiot, but can you work this obviousness out comparing TIPS in retirement to I-Bond in taxable. It's not obvious to me. I wouldn't hold TIPS in taxable for the same reason I don't hold I-bonds - the taxes make them a guaranteed loser with respect to inflation. I haven't seen anybody adequately address the fact that for I-bonds because all of your gain is taxable interest, then the real return is guaranteed to be negative.

While TIPS currently have a negative real yield, which is unfortunate, that's a recent phenomena. We are trying to figure out if
Ibonds [0% plus inflation*(1-taxes)] will outperform TIPS in a retirement account [-1.25% + inflation}.

For Ibonds to be the winner, inflation*taxes must be less than 1.25%. This certainly depends on the value of inflation with the benefit swinging wildly to TIPS as inflation increases. Why is this wrong?
I'm not sure that I understand how there can be a single formula that would apply to all scenarios, so I looked at what my own results would be were I making this choice.

I think the worst case for I-bonds would be that the money has to be taken out of a tax-deferred account (or displaces what would've been contributions). This is what I would have to do to buy I-bonds, so I did a quick analysis and using -1.25% for TIPS and a 5 year time frame, it would take about 13% inflation before the TIPS in tax deferred come out ahead.

I first compared $1000 in TIPS to $800 in I-bonds, since I would pay 20% tax in taking the money out of tax deferred. Then at the end of 5 years the gains on I-bonds are taxed at my 12% Federal rate, while the entire TIPS balance is taxed at 20%.

Using 10 years, with TIPS rate of -1%, the result was similar the TIPS did not come out ahead until inflation was 13-14%.

If I assume the money is coming from a Roth, it does not change things. It still takes 13-14% inflation for TIPS to win. In this case, I have $1000 to put in I-bonds, since there would be no tax on the withdrawal and there is no tax on the ending TIPS balance either.

This confirms something I said in another discussion, that while I am using neither TIPS nor I-bonds, if I had to choose one or the other it might very well be the I-bonds, even though I would have to pull money from tax-deferred accounts in order to buy the I-bonds.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Buffetologist »

Walkure wrote: Tue Aug 11, 2020 3:46 pm
Buffetologist wrote: Tue Aug 11, 2020 12:51 pm
JackoC wrote: Tue Aug 11, 2020 9:23 am
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious.
Maybe I'm an idiot, but can you work this obviousness out comparing TIPS in retirement to I-Bond in taxable. It's not obvious to me. I wouldn't hold TIPS in taxable for the same reason I don't hold I-bonds - the taxes make them a guaranteed loser with respect to inflation. I haven't seen anybody adequately address the fact that for I-bonds because all of your gain is taxable interest, then the real return is guaranteed to be negative.

While TIPS currently have a negative real yield, which is unfortunate, that's a recent phenomena. We are trying to figure out if
Ibonds [0% plus inflation*(1-taxes)] will outperform TIPS in a retirement account [-1.25% + inflation}.

For Ibonds to be the winner, inflation*taxes must be less than 1.25%. This certainly depends on the value of inflation with the benefit swinging wildly to TIPS as inflation increases. Why is this wrong?
I believe the comparison accounts for the fact that holding I-bonds instead of TIPS frees up retirement space for other assets, so the deferred taxes on I-bonds are being offset by the stocks that can be shifted out of taxable.
Interesting point that I hadn't thought of. Thanks!
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Robot Monster »

diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?

Thanks, everyone.
BlackRock has both a strategic and tactical preference for corporate bonds over government bonds, so perhaps consider either going short-term corporate or ultra-short term corporate,
https://www.blackrock.com/us/individual ... onal-views

On the other hand, since no one knows nothing, you could very well stand to do better ignoring this advice, and instead choose something completely at random.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by protagonist »

diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?

Thanks, everyone.

You can never go wrong with I-bonds, especially if your main goal is asset preservation. But your investment threshold is limited.

I would be very skittish about investments which will lose real value if interest rates or inflation rise, especially longer term investments, in this climate.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by #Cruncher »

Buffetologist wrote: Tue Aug 11, 2020 12:51 pmWe are trying to figure out if Ibonds [0% plus inflation*(1-taxes)] will outperform TIPS in a retirement account [-1.25% + inflation}.
The following table shows the breakeven inflation rate. I.e., the inflation rate at which the after tax value of a 0% fixed rate I Bond equals the value of a TIPS in a Roth IRA. [1] For example, with a 10% tax rate annual inflation would need to be 34.2% for a 10-year TIPS yielding -0.99% [2] to grow to the same value as the I Bond after taxes. But with a 37% tax rate, annual inflation would need to be only 3.0% [3].

Code: Select all

Row  Col A               Col B    Col C    Col D    Col E 
  1  IBond fixed rate    0.00%
  2             Years       5       10       20       30
  3  Tax / TIPS yield   (1.23%)  (0.99%)  (0.48%)  (0.37%)
     ---                 -----    -----    -----    -----
  4  10%                 20.1%    34.2%    13.3%     n/a 
  5  12%                 14.9%    16.8%     7.5%     7.2%
  6  22%                  6.6%     5.8%     2.7%     2.2%
  7  24%                  5.9%     5.1%     2.4%     1.9%
  8  32%                  4.2%     3.6%     1.7%     1.3%
  9  35%                  3.8%     3.2%     1.5%     1.2%
 10  37%                  3.6%     3.0%     1.4%     1.1%
To use these formulas with different assumptions, select all, copy, and paste [4] the following at cell A1 of a blank Excel sheet. Then copy cell B4 down to row 10 and right to column E.

Code: Select all

IBond fixed rate	0
           Years	5	10	20	30
Tax / TIPS yield	-0.0123	-0.0099	-0.0048	-0.0037
0.1	=($A4/((1+B$3)^B$2-(1+$B$1)^B$2*(1-$A4)))^(1/B$2)-1
0.12
0.22
0.24
0.32
0.35
0.37
  1. If the tax rate now is the same as the tax rate at the end, the results would apply to a traditional IRA as well as a Roth IRA.
  2. Except for 20 years, the TIPS yields are from Daily Treasury Real Yield Curve Rates for 8/11/2020. For 20 years I'm averaging Tuesday's yields for the Feb 2040 (-0.504%) and Feb 2041 (-0.457%) TIPS from WSJ TIPS Quotes.
  3. Confirmation showing that $1 invested in a 10-year TIPS yielding -0.99% grows to same value as $1 invested in a 0% fixed rate I Bond if 37% tax and 3.0% inflation:
    TIPS ... 1.217 = (0.9901 * 1.03) ^ 10
    IBond . 1.217 = 1.03 ^ 10 - 37% * (1.03 ^ 10 - 1)
  4. If you have trouble pasting, try "Paste Special" and "Text".
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Angst »

#Cruncher wrote: Wed Aug 12, 2020 12:03 pm The following table shows the breakeven inflation rate. I.e., the inflation rate at which the after tax value of a 0% fixed rate I Bond equals the value of a TIPS in a Roth IRA. [1] For example, with a 10% tax rate annual inflation would need to be 34.2% for a 10-year TIPS yielding -0.99% [2] to grow to the same value as the I Bond after taxes. But with a 37% tax rate, annual inflation would need to be only 3.0% [3].

Code: Select all

Row  Col A               Col B    Col C    Col D    Col E 
  1  IBond fixed rate    0.00%
  2             Years       5       10       20       30
  3  Tax / TIPS yield   (1.23%)  (0.99%)  (0.48%)  (0.37%)
     ---                 -----    -----    -----    -----
  4  10%                 20.1%    34.2%    13.3%     n/a 
  5  12%                 14.9%    16.8%     7.5%     7.2%
  6  22%                  6.6%     5.8%     2.7%     2.2%
  7  24%                  5.9%     5.1%     2.4%     1.9%
  8  32%                  4.2%     3.6%     1.7%     1.3%
  9  35%                  3.8%     3.2%     1.5%     1.2%
 10  37%                  3.6%     3.0%     1.4%     1.1%
This is interesting, thank you #Cruncher. If I understand your presentation correctly, it seems to put I Bonds purchased today (given the current real yield curve) in a fairly good light vs. TIPS in a Roth IRA, especially for one who expects to be in a low tax bracket when redeeming them.

Am I correct to be reading these "annual inflation" percentages to mean average annual inflation over the 30 (or 20, 10 or 5) years preceding redemption?

Why do we get "n/a" for 30 years at a 10% tax bracket?
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by JackoC »

Buffetologist wrote: Tue Aug 11, 2020 12:51 pm
JackoC wrote: Tue Aug 11, 2020 9:23 am
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious.
Maybe I'm an idiot, but can you work this obviousness out comparing TIPS in retirement to I-Bond in taxable. It's not obvious to me. I wouldn't hold TIPS in taxable for the same reason I don't hold I-bonds - the taxes make them a guaranteed loser with respect to inflation. I haven't seen anybody adequately address the fact that for I-bonds because all of your gain is taxable interest, then the real return is guaranteed to be negative.

While TIPS currently have a negative real yield, which is unfortunate, that's a recent phenomena. We are trying to figure out if
Ibonds [0% plus inflation*(1-taxes)] will outperform TIPS in a retirement account [-1.25% + inflation}.

For Ibonds to be the winner, inflation*taxes must be less than 1.25%. This certainly depends on the value of inflation with the benefit swinging wildly to TIPS as inflation increases. Why is this wrong?
I was assuming both were in taxable. The original question says nothing about this either way. I perhaps should have stated that, but OTOH once you introduce IRA v taxable it's also more complicated than you present it. In the sense other posts also noted: the value of tax deferral in (a Traditional) IRA/401k will benefit *some* asset whether it's your TIPS or something else. If it's one tiny smidgen better to have TIPS in IRA than an I-Bond that doesn't decide it. You have to also include what you lose from pushing $10k of other assets/activities (tax free rebalancing trades etc) out of the IRA to make room for the TIPS.

Besides which, your equation leaves out the ending tax payment in the Traditional IRA case. I believe the equations for final payoff of $10k after tax ($10/(1-tax rate) in earnings) purchase of 0% fixed rate I-Bond v $10k/(1-tax rate) pretax contribution to Trad IRA/401k, invested in 5 yr TIPS at inflation-1.25% yield would be:
I-Bond:
$10k*(1+(((1+inflation)^n)-1)*(1-tax rate)).
IRA/TIPS:
($10k/(1-tax rate))*(1+inflation-1.25%)^n)*(1-tax rate).

This is assuming 'inflation rate' and 'tax rate' are constant. Some investors choose Trad tax deferred specifically because they think 'later tax rate' will lower than 'current tax rate' for them. But here I'm just answering the simple case you proposed and assuming one 'tax rate'.

For inflation=1.25% you always get $10k at the end in TIPS/IRA case. Whereas for n=5, inflation=1.25%, tax rate=30% you get $10,448 in the I-bond case, and the two are equal around inflation=~4.75%. And it's really not counter intuitive IMO that TIP yielding inflation **-1.25%** would have so much trouble beating inflation + 0% if the only other difference is tax deferral mechanics.

If comparing to the 30 yr TIPS at yield of -.35% it's much more favorable for Trad IRA/TIPS even though the -.35% is compounding over n=30. In that case the payoffs are equal at tax rate-30% where inflation = ~1.35% (v the TIPS/nominal treas break even of around 1.7% in 30 yrs). Although, that ignores the value of my option to replace the 0% I-Bond with a higher yielding I-Bond after 5 yrs if I-Bond fixed rates go up (though traded off against my future ability to buy more net I-Bonds at $10k/yr). But again, once the IRA/TIPS has any advantage then Stage II of analysis: is that advantage worth losing tax deferral on whatever asset gets 'pushed out' of the Trad IRA/401k to make room for TIPS? In my case I would not consider pushing $10k of various other assets/activities out of my IRA to make room for $10K more TIPS, when I can just buy an I-Bond, unless TIPS was far superior.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by grabiner »

At current yields, I-Bonds are clearly better than TIPS in a taxable account. I-Bonds have a yield of zero above inflation, and the tax is deferred until you cash them in. TIPS have a negative real yield, so they are guaranteed to underperform inflation if held to maturity.

Thus, if you have a taxable account, and want inflation protection, buy I-Bonds in preference to buying TIPS in any account.

If you do need to hold TIPS, they are among the most tax-efficient bonds. The low risk means that they have low yields, and the dividend is exempt from state tax. Therefore, if you are going to hold bonds in your taxable account, and hold TIPS somewhere, the TIPS should probably be in your taxable account. (A possible exception is munis in a high tax bracket.)
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by willthrill81 »

JackoC wrote: Tue Aug 11, 2020 9:23 am
diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious. Only doable up to the purchase limit for I-Bonds obviously, but while that's not enough for I-Bonds to be the 'solution' for many investors, there aren't that many investors where $10k per person/yr is a totally negligible amount either.
Bingo. I-bonds are the clear and indisputable winner right now, and the margin isn't very close either.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Rob5TCP »

willthrill81 wrote: Wed Aug 12, 2020 4:02 pm
JackoC wrote: Tue Aug 11, 2020 9:23 am
diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?
For direct inflation protection, I-Bonds are now far superior to TIPS. Often in the past there was room for debate about this, but with the 5 yr TIPS yield at around -1.25% and I-Bond (puttable with full interest at 5 yrs) fixed rate 0% this is completely obvious. Only doable up to the purchase limit for I-Bonds obviously, but while that's not enough for I-Bonds to be the 'solution' for many investors, there aren't that many investors where $10k per person/yr is a totally negligible amount either.
Bingo. I-bonds are the clear and indisputable winner right now, and the margin isn't very close either.
+1 At least for the first $10,000.00
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by abuss368 »

diyinvestor wrote: Mon Aug 10, 2020 2:11 pm I must admit something: I find bonds confusing. I've got a bit of cash to enhance my bond holdings. What is the best choice right now? Should I buy a TIPS fund, I-Bonds, U.S. Treasuries, or Short-Term Corporate bonds?

Thanks, everyone.
Unless you are exposed to unexpected inflation there should be no need for a separate TIPS fund. Equities, Fixed Costs, Wages, Social Security are inflation adjusted.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by #Cruncher »

Angst wrote: Wed Aug 12, 2020 2:06 pmIf I understand your presentation correctly, it seems to put I Bonds purchased today (given the current real yield curve) in a fairly good light vs. TIPS in a Roth IRA, especially for one who expects to be in a low tax bracket when redeeming them.
I agree. The only case [1] I can think of where TIPS would be the better choice would be where the investor
  1. Has free space in and can contribute to a Roth or traditional retirement account.
  2. Has only a slight expectation of needing the inflation-indexed principal before 30 years.
  3. Wants to guard against inflation running at more than 2% over the next 30 years.
  4. Anticipates having a federal tax rate of 32% or higher in 30 years.
Here is an update of the table from my previous post. The only difference is that I've entered 0.15% as the I Bond fixed rate. This reflects my guess that the I Bond 0% composite rate floor feature [2] will increase the return of a 0% fixed rate I Bond by this annual rate over its lifetime. [3]

Code: Select all

  1  IBond fixed rate    0.15%
  2             Years       5       10       20       30
  3  Tax / TIPS yield   (1.23%)  (0.99%)  (0.48%)  (0.37%)
     ---                 -----    -----    -----    -----
  4  10%                 24.7%     n/a      n/a      n/a 
  5  12%                 17.6%    25.9%    24.6%     n/a 
  6  22%                  7.4%     6.8%     3.8%     3.5%
  7  24%                  6.6%     6.0%     3.3%     3.0%
  8  32%                  4.7%     4.1%     2.2%     1.871% <==
  9  35%                  4.2%     3.6%     1.9%     1.6%
 10  37%                  3.9%     3.4%     1.8%     1.5%
Angst, continuing in same post, wrote: Am I correct to be reading these "annual inflation" percentages to mean average annual inflation over the 30 (or 20, 10 or 5) years preceding redemption?
Yes.
Angst, continuing in same post, wrote:Why do we get "n/a" for 30 years at a 10% tax bracket?
It's because the formula generates Excel's #NUM error in those cells. [4] I'd read these cases as meaning only hyper inflation could cause the TIPS value to break even with the I Bond's after tax value.

JackoC wrote: Wed Aug 12, 2020 3:18 pm I-Bond: $10k*(1+(((1+inflation)^n)-1)*(1-tax rate)).
This is correct for a 0% fixed rate I Bond. Here is a more general formula showing what $1 invested in an I Bond will grow to after taxes. Also shown is the formula for the TIPS value and examples for the case of 30 years and a 32% tax rate where
f = I Bond fixed rate
r = TIPS yield
i = annual inflation rate
n = years
t = tax rate

Code: Select all

IBond $ = ((1 + f) * (1 + i) ) ^ n  * (1 - t)    + t
  1.560 = ( 1.0015 *  1.01871) ^ 30 * (1 - 0.32) + 0.32
  
 TIPS $ = ((1 + r) * (1 + i) ) ^ n
  1.560 = ( 0.9963 *  1.01871) ^ 30
  1. vineviz gives another case for preferring long term TIPS to I Bonds in his post, Re: Inflation, TIPS and asset allocation where an investor can play off the interest rate risk of a TIPS against that of a planned future annuity purchase. Because they are not marketable, I Bonds could not serve this function. But since inflation-indexed annuities are no longer offered (I have heard), a long term nominal Treasury would be a better offset than a TIPS.
  2. See TreasuryDirect's Combining the two rates.
  3. For more on the effect of the floor see my post, Re: Just how good is I-bonds' nominal guarantee during deflation?
  4. This happens because the formula uses the "^" operator with a non-integer exponent applied against a negative value. See "Remarks" here.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by Angst »

Thank you #Cruncher for the clarifications above. Clearly, I Bonds are presently a good option for many people to consider.

And thank you for the updated table you posted. I had naively assumed you'd already somehow incorporated the math required to account for the I Bond's benefits from its "rate floor feature" (vs. TIPS' rather weak deflation protection) into your original table. Not being able to fully wrap my mind around the calculations involved, I'm still more than willing to assume that the 1998-2015 data you used [3] is sufficient for considering future inflation/deflation scenarios over as long as 30 years out in comparing I Bonds to TIPS. I had missed that thread, thank you. Great post.

#Cruncher wrote: Thu Aug 13, 2020 8:11 amHere is an update of the table from my previous post. The only difference is that I've entered 0.15% as the I Bond fixed rate. This reflects my guess that the I Bond 0% composite rate floor feature [2] will increase the return of a 0% fixed rate I Bond by this annual rate over its lifetime. [3]

Code: Select all

  1  IBond fixed rate    0.15%
  2             Years       5       10       20       30
  3  Tax / TIPS yield   (1.23%)  (0.99%)  (0.48%)  (0.37%)
     ---                 -----    -----    -----    -----
  4  10%                 24.7%     n/a      n/a      n/a 
  5  12%                 17.6%    25.9%    24.6%     n/a 
  6  22%                  7.4%     6.8%     3.8%     3.5%
  7  24%                  6.6%     6.0%     3.3%     3.0%
  8  32%                  4.7%     4.1%     2.2%     1.871% <==
  9  35%                  4.2%     3.6%     1.9%     1.6%
 10  37%                  3.9%     3.4%     1.8%     1.5%
  1. vineviz gives another case for preferring long term TIPS to I Bonds in his post, Re: Inflation, TIPS and asset allocation where an investor can play off the interest rate risk of a TIPS against that of a planned future annuity purchase. Because they are not marketable, I Bonds could not serve this function. But since inflation-indexed annuities are no longer offered (I have heard), a long term nominal Treasury would be a better offset than a TIPS.
  2. See TreasuryDirect's Combining the two rates.
  3. For more on the effect of the floor see my post, Re: Just how good is I-bonds' nominal guarantee during deflation?
  4. This happens because the formula uses the "^" operator with a non-integer exponent applied against a negative value. See "Remarks" here.
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Re: Buy TIPS Mutual Fund or I-Bonds?

Post by vineviz »

#Cruncher wrote: Thu Aug 13, 2020 8:11 am
  1. vineviz gives another case for preferring long term TIPS to I Bonds in his post, Re: Inflation, TIPS and asset allocation where an investor can play off the interest rate risk of a TIPS against that of a planned future annuity purchase. Because they are not marketable, I Bonds could not serve this function. But since inflation-indexed annuities are no longer offered (I have heard), a long term nominal Treasury would be a better offset than a TIPS.
The duration-matched TIPS is superior to a nominal bond in this case (i.e. setting aside a reserve fund at year 0 to purchase an annuity in year T) because it accomplishes all three important purposes: it will adjust for changes in real rates between years 0 and T, it will reflect expected inflation at year T, and it will adjust for realized inflation between years 0 and year T. A nominal bond will address the first two goals, but not the third.
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