What's up (or down) with TIPS?

[Kevin M]

The purpose of this thread is to discuss any and all topics related to TIPS (Treasury Inflation Protected Securities), and only TIPS. There are lots of other threads focused on various aspects of TIPS, and of course post there if it's appropriate, but if anyone has any questions, observations, or anything else they'd like to discuss that doesn't fit nicely into another current thread, feel free to post it here. Questions can be absolute newb questions, like what are TIPS, how to buy them, or how the inflation adjustments are calculated, or more advanced questions, like "what is an outlier factor and why might one need to be applied in addition to a seasonal adjustment?" Huh?

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In addition to the bit I added above, in blue, I'd really like to keep this thread focused on TIPS-specific discussion, so folks coming here to learn about TIPS don't get scared away, or too distracted by tangential debates. For example, this is not a thread to discuss:

• TIPS vs. stocks. As of this writing, there's an active thread, currently up to 5 pages, where that is being discussed extensively, so please go there if that's your interest: Why (or at what YTM) does it make sense to buy a 20+ year TIPS...? - Bogleheads.org
• TIPS vs. I bonds. There are many, many threads where this has been discussed at length--no need to rehash it here, and again, the point of this thread is to consolidate TIPS knowledge. Here's a Google search that returns plenty of links to TIPS and I bonds discussions:

  Code: Select all

  tips "i bonds" site:bogleheads.org

  You can just type the first part into the Google search box at the top left of this page to do this search. The first link is to a Wiki article on the topic.

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Speaking of BH wiki articles, there's one for TIPS. My original thought was to provide links to useful threads and websites, but I didn't get around to it. I'll start that now. In this section I'll also add links to posts in this thread that deal with topics that tend to come up frequently

Links to other TIPS web pages:

• BH wiki: Treasury Inflation Protected Security - Bogleheads
• The TIPS part of #Crunchers TIPS and I bonds website: TIPS - Home. Extremely useful for reference CPI, index ratios, and a ton of other TIPS-related stuff.
• Probably a good starting point for all newbs, and a good resource for all TIPS-interested folks: TIPS — TreasuryDirect
• Forum member Harry Sit, aka The Finance Buff, has written a good, short book on TIPS, and loads of blog posts. Here's a web search to get you started:

  Code: Select all

  tips site:https://thefinancebuff.com/blog

Links to selected posts in this thread:

• TIPS liquidity premium and inflation risk premium
• TIPS liquidity premium and inflation risk premium: derivations and conclusions
• TIPS auction schedule

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What's up with TIPS today are long-term TIPS yields, and what's down are long-term TIPS prices; remember that for bonds, price and yield are inversely related, so when one is up the other is down. I know this without even looking at any TIPS yields because the price of the very long-term TIPS ETF, LTPZ, is down about 1.3%; LTPZ holds about 43% of its portfolio on 10-20 year TIPS and the rest in 20-30 year TIPS, with an average maturity of about 22 years and average duration of about 19 years.

I tend to get more interested in doing TIPS trades when yields move up, so I did a couple trades today. I'll share what I traded and why, but first, the background.

I currently have nothing but TIPS in my IRA. They are laddered out to 2047, with approximately the same annual real cash flows each year from 2028-2047, but with 57% of my TIPS maturing 2025-2027--the first three years of my 23-year ladder. With all of these short-term TIPS, the market-weighted average duration of my TIPS "ladder" is about 6.2 years, but for a 23-year investment horizon it should be closer to 10 years; if a 2036 TIPS (midpoint between 2025 and 2047) were issued today, the duration would be about 10.3 years.

This duration goal applies if I want to match the average duration of my TIPS portfolio to that of my expected residual liabilities during the 23-year investment horizon. People who use TIPS funds to simulate a TIPS ladder use a duration matching approach something like this. If I had equal rungs in my ladder, I wouldn't have to worry about duration, since the timing of the real cash flows would match the timing of the expected residual liabilities. By "residual liabilities" I mean the expected real consumption not covered by Social Security income (I don't have a pension or any annuities).

Matching the duration of a bond portfolio to the investment horizon matters if we want to balance the price risk and reinvestment risk components of interest rate risk (aka term risk). If we have a higher tolerance for one or the other components of term risk, we may not want to match the duration of the bond portfolio to the investment horizon. The latter is one reason I've objected to some posts that simply state this duration matching as an axiom, without any qualifications.

I tend to be more sensitive to price risk than to reinvestment risk, which probably is due to the cognitive bias of short term thinking, but also probably to a long period of low and generally declining yields from about 2010 to mid-2020 (during much of which time I held mostly 5-year direct CDs at large yield premiums over 5-year Treasuries). This is why I ended up with so much of my TIPS portfolio in shorter term TIPS, after being shocked into action by the unexpectedly high inflation that began in 2021. Once I became comfortable enough with the evidence that current long-term TIPS yields are historically attractive, I started adding longer term TIPS to my portfolio, then I decided to just build an actual ladder targeting a Desired Annual Real Amount (DARA) for each rung.

I still like to move into new territory gradually, so rather than just selling all of my excess shorter-term TIPS and building a 23-year ladder with equal rungs, I've been gradually selling my soonest-to-mature TIPS and using the proceeds to add to my longer-term rungs. I started with my Jan 2024 TIPS, then moved on to my Jul 2024s, and finally my Oct 2024s, after which I paused for awhile.

Today I decided to start selling some of my 2025s to buy some longer maturities. I'm still hoping for even higher yields on the longest-term TIPS in my ladder, but the prices change much less for 202X TIPS than for 204X TIPS, for example, so I'm more comfortable adding to my 202X rungs right now. That brings us to today's trades.

I sold 10 of my Apr 2025s, and used the proceeds, plus a little extra cash from my minimal money market fund holding, to buy 12 Apr 2028s. Why did I select these particular maturities to sell and buy?

I hold a large excess of Jan, Apr, Jul and Oct 2025s. To increased my average duration by the most, I would sell the Jan, with the shortest duration, but due to the inverted yield curve, the seasonally adjusted (SA) yield of the Jan is 33 basis points higher than that of the Apr, so I decided to sell Apr instead. As a secondary consideration, I hold roughly equal real principal amounts of Jan and Jul for later maturities.

I already hold Jan and Jul 2028, but I kind of like have TIPS maturing more often if possible, so I decided to depart from my Jan+Jul maturities approach and add some of the Apr.

Previously when yields had increased to levels above my average yields for each maturity for the ladder I built with my initial DARA, I increased my DARA by 20%, then added to every rung to get there. Yields haven't increased much since then, so instead of increasing my DARA for all rungs, I decided to just start adding to the later 202X rungs.

[JBTX]

I’ll bite. I’m a relative newbie and started putting together a TIPS ladder in a fidelity IRa. I bought TIPs on the market. What I’m not sure of is when I did it, how can I be sure that I am buying at the best price? Does fidelity (or vanguard ) let you buy at suboptimal prices.

Question 2

I think this is probably obvious but when building a ladder at positive real rates, do people typically buy a lower face amount the farther you go out, given real rates are positive?

[FactualFran]

The purpose of this thread is to discuss any and all topics related to TIPS (Treasury Inflation Protected Securities). There are lots of other threads focused on various aspects of TIPS, and of course post there if it's appropriate, but if anyone has any questions, observations, or anything else they'd like to discuss that doesn't fit nicely into another current thread, feel free to post it here. Questions can be absolute newb questions, like what are TIPS, how to buy them, or how the inflation adjustments are calculated, or more advanced questions, like "what is an outlier factor and why might one need to be applied in addition to a seasonal adjustment?" Huh?

What's up with TIPS today are long-term TIPS yields, and what's down are long-term TIPS prices; remember that for bonds, price and yield are inversely related, so when one is up the other is down. I know this without even looking at any TIPS yields because the price of the very long-term TIPS ETF, LTPZ, is down about 1.3%; LTPZ holds about 43% of its portfolio on 10-20 year TIPS and the rest in 20-30 year TIPS, with an average maturity of about 22 years and average duration of about 19 years.

I tend to get more interested in doing TIPS trades when yields move up, so I did a couple trades today. I'll share what I traded and why, but first, the background.

If this topic is for "anything else they'd like to discuss that doesn't fit nicely into another current thread", then trades of TIPS should not be posted here but in the existing Trading Treasuries (nominal and TIPS) topic. An alternative would be to start a TIPS Mega Thread for all things TIPS.

[Johnnie]

I'm pretty much a TIPS newb - bought a slug of 5-years for my Vanguard rollover IRA at the April 2024 auction. As a newb, I wanted to keep things as simple as possible, which is why I bought 'new-born' bonds at auction.

I'm looking to add to this position at the June 20 "reopening" auction. As I understand it, I will get new bonds from the Treasury that also mature in April, 2029, at the price and "real rate" in effect on the June 28 settlement day. They'll be "four year and 10 month" bonds then. Does that sound right?

One thing that has surprised me is the amount of volatility in the month-to-month real rate of a particular issue - the April 2029s, in this case.

[Dufus]

I recently bought some 2034 Tips and will sell some of the 2033 to cover that when the price exceeds what I paid.

I wish you could put in a limit order for TIPS and the order would just sit there until filled or cancelled. What are the odds of that eventually becoming a thing?

[#Cruncher]

... bought a slug of 5-years for my Vanguard rollover IRA at the April 2024 auction. ... I'm looking to add to this position at the June 20 "reopening" auction. As I understand it, I will get new bonds from the Treasury that also mature in April, 2029, at the price and "real rate" in effect on the June 28 settlement day. They'll be "four year and 10 month" bonds then. Does that sound right?

Mostly correct. You'll get bonds with the same 2-1/8% coupon, 4/15/2029 maturity date, and 91282CKL4 CUSIP number as the ones initially auctioned in April. The yield or "real rate" will be determined by the bidding at the June 20th auction. The price will then be determined by formula as of the June 28th issue date. The price will vary inversely with the yield. This is shown in cells B16:B26 below for several possible yields. Cells C16:C26 show the corresponding inflation-adjusted cost for ten $1,000 bonds including accrued interest.

Code: Select all

Row                   Col A       Col B        Col C        Selected Formulas
  2              Face value      10,000
  3   Index ratio 6/28/2024     1.01332
  4                  Issued   6/28/2024
  5                 Matures   4/15/2029
  6                  Coupon      2.125%
  7  Previous interest date   4/15/2024                B7: =COUPPCD(B4,B5,2,1)
  8      Next interest date  10/15/2024                B8: =COUPNCD(B4,B5,2,1)
  9  Days in current period         183                B9: =B8-B7
 10       Days before issue          74               B10: =B4-B7
 11        Days after issue         109               B11: =B8-B4
 12     Number full periods           9               B12: =COUPNUM(B4,B5,2,1)-1
 13   Unadj accr int / $100    0.429645               B13: =ROUND(100*(B6/2)*(B10/B9),6)

Code: Select all

 14                          Unadjusted    Cost Incl
 15       Yield to maturity       Price  Accrued Int
 16                  2.000%     100.567       10,234  B16: =100*(-PV(A16/2,B$12,B$6/2,1,0)+B$6/2)/(1+(A16/2)*(B$11/B$9))-B$13
 17             ===> 2.050%  100.338480    10,211.04        | | | <===
 18                  2.100%     100.111       10,188        | | |
 19                  2.150%      99.884       10,165        | | |
 20                  2.200%      99.657       10,142        v v v
 21                  2.250%      99.432       10,119  B21: =100*(-PV(A21/2,B$12,B$6/2,1,0)+B$6/2)/(1+(A21/2)*(B$11/B$9))-B$13
 22                  2.300%      99.206       10,096  C22: =B$3*(B22+B$13)*(B$2/100)
 23                  2.350%      98.982       10,074        | | |
 24                  2.400%      98.758       10,051        | | |
 25                  2.450%      98.534       10,028        v v v
 26                  2.500%      98.311       10,006  C26: =B$3*(B26+B$13)*(B$2/100)

References:

• Initial Auction Results PDF
• Tentative Auction Schedule PDF
• Index Ratios
• COUPPCD function
• COUPNCD function
• COUPNUM function
• PV function
  
  Edited 5/29/2024 to add MtnBiker's auction schedule below formatted as a table:

  Code: Select all

                5-Yr    10-Yr    30-Yr
    January              New 
   February                       New 
      March            Reopen
      April     New 
        May            Reopen
       June   Reopen
       July              New 
     August                     Reopen
  September            Reopen
    October     New 
   November            Reopen
   December   Reopen

  Edited 6/20/2024 to report actual 2.050% high yield from the auction:
  Total cost of $10,000 face value purchase including accrued interest:
  $10,211.04 = 10000 * 1.01332 * (100.338480 / 100 + 4.29645 / 1000)

[MIretired]

What denominations (time to maturity) are frequently/regularly/usually offered at auctions? 1, 3, 5, 10, 30yr?

[MtnBiker]

What denominations (time to maturity) are frequently/regularly/usually offered at auctions? 1, 3, 5, 10, 30yr?

The monthly TIPS auction schedule has not changed since 2019.

January. New 10-year TIPS.
February. New 30-year TIPS.
March. Reopening of January 10-year.
April. New 5-year TIPS.
May. Reopening of January 10-year.
June. Reopening of April 5-year.
July. New 10-year TIPS.
August. Reopening of February’s 30-year.
September. Reopening of July 10-year.
October. New 5-year TIPS.
November. Reopening of July 10-year.
December. Reopening of October 5-year.

Source: https://tipswatch.com/upcoming-tips-auctions/

[MtnBiker]

I’ll bite. I’m a relative newbie and started putting together a TIPS ladder in a fidelity IRa. I bought TIPs on the market. What I’m not sure of is when I did it, how can I be sure that I am buying at the best price? Does fidelity (or vanguard ) let you buy at suboptimal prices.

Question 2

I think this is probably obvious but when building a ladder at positive real rates, do people typically buy a lower face amount the farther you go out, given real rates are positive?

Answering Q1, Vanguard and Fidelity have a slightly larger bid/ask spread than at Schwab. So, the pricing you get on small orders is slightly less optimal than at Schwab.

But my experience at Vanguard is that pricing is fair. I think the prices you are offered are the same everywhere except for the spread. You agree on the price you are willing to pay, place the order and the price you get is what you agreed on or better.

If you place a buy order during a period of time in which prices are falling, the order may fill at a lower price than you expected.

If you place a buy order during a period of time when prices are increasing rapidly, there is a possibility that your order will not be filled. It will appear as canceled within a few minutes. You then have to place a new buy order at a higher price if you want to continue.

[well9boy9]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?) logic.

[BirdFood]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

[well9boy9]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

[watchnerd]

I recently bought some 2034 Tips and will sell some of the 2033 to cover that when the price exceeds what I paid.

What happens if the price never exceeds what you paid?

[BirdFood]

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

Are you saying that when the Fed increases interest rates to reduce inflation, that actually increases inflation? That doesn’t seem to be the common understanding.

And, again, the reduction in TIPS value on the secondary market when interest rates go up is irrelevant if you hold them to maturity.

[watchnerd]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

Why does that matter?

If you hold your individual TIPS to maturity, you receive your real yield, regardless.

[Kevin M]

I'm happy to see people taking advantage of this thread to post questions, and that some of them have already been answered. I'll look back through all questions periodically, and add my 2 cents if I think it's warranted.

Today LTPZ (15+ year TIPS ETF) price is down pretty big again--change from yesterday's close is -0.88% as of the latest quote using the Google Sheets GoogleFinance function. Yesterday it was down even more--something like -1.4% at one point, IIRC.

Just pulled ask yields from Schwab, and the high yields are for the 2046-2048, all at 2.43%. The 2044, 45 and 49 are at 2.42%. Here's the full yield curve, also showing seasonally-adjusted (SA) and SA with additional outlier factors applied as necessary to smooth out wiggles that I can't explain (SA+O):



Here's a chart of the maturities through 2034, where it's easier to see the irregularities due to seasonal effects, which are more pronounced at shorter maturities, and the additional smoothing achieved by applying the outlier factors.



Note that Oct maturities are the ones with the largest irregularities after applying the SA smoothing, and the outlier factor push the yields in the opposite direction of the SA factors--it's like the seasonal adjustments are overcompensating. Further discussion of outlier factors might be more appropriate in a TIPS seasonal adjustment thread, like TIPS yield curve and seasonal adjustment update - Bogleheads.org; it's something that we've never discussed as far as I know.

Although it may be more appropriate to discuss trades in the Trading Treasuries thread, here I'm doing so more as a consequence of other things I'm sharing about TIPS. I'll almost certainly do another swap today, maybe even pushing maturity out a bit more than the 2028 I bought yesterday.

I'll note that my high yield on a 2044 purchase was 2.46% (2.45% SA), and now it's at 2.42% (2.39% SA), but my weighted average yield is 2.10% (2.09% SA).

Here's a chart of the Feb 2044 yields over the last year through Friday (today is Wednesday):



We see that today's yield of 2.42% is pretty close to the recent high of 2.46% on Apr 25 (about a month ago), but still quite a way below the 1-year high of 2.685 on Oct 25, 2023. I'm kind of hoping for something closer to the Oct 2023 highs before adding more 2040s or beyond.

The 2034 is at 2.26% (2.25% SA), while my high yield was 2.24% (SA 2.26%) for a purchase on 04/24/24, and my weighted average yield is 2.01% (SA 2.04%). There's no FRED chart for the 2034 (too new), but here's one for the Apr 2032:



The high yield for the Apr 2032 was 2.62 on Oct 25, 2023, recent high was 2.29 on Apr 30, 2024, and today it's 2.27 (2.22 SA). I'll probably hold off on going out this far for now.

I need to run to a medical appointment soon, so I'll look at this more closely when I get back.

[Retired in CA]

Couple of quick questions about this graph:

1. The SA line seems to disappear after 2031. Is that because it's perfectly covered by the SA+O line?

2. From 2040 out to the end, the SA+O line appears to be consistently below the A line. Why is that happening? Could you share your smoothing algorithm?

Thanks.

[Kevin M]

Couple of quick questions about this graph:

1. The SA line seems to disappear after 2031. Is that because it's perfectly covered by the SA+O line?

2. From 2040 out to the end, the SA+O line appears to be consistently below the A line. Why is that happening? Could you share your smoothing algorithm?

Thanks.

Good questions.

1. Yes. For whatever reason, the orange dominates the red. I'm experimenting with using different point shapes to try and get the SA to show up at least a little bit without cluttering the chart at the short end.

2. It has to do with the ratio of Ref CPI SA factor at settlement mm/dd to ref CPI SA factor at maturity mm/dd. To get deeply into this we should move the discussion to the seasonal adjustments thread, which I linked to above, but here's an answer that may help enough for the purposes of this thread.

To get SA yield we first need SA price, which is quoted price multiplied by the ratio of SA factors for settlement and maturity. When the former is larger than the latter, the price SA factor is > 1, so SA price is > quoted price, which means SA yield is < SA yield, and vice versa.

The Settlement SA factor (SSA), maturity SA factor (MSA), and price SA factor (PSA) are the same for any Feb 15 maturity today, with settlement tomorrow, 5/30/2024. I'll use the 2054 as an example.

Code: Select all

Settlement SA factor = 1.00016
Maturity SA factor = 0.99524
Price SA factor = SSA/MSA = 1.00016 / 0.99524 = 1.00494
SA price = ask price * PSA = 94.336 * 1.00494 = 94.802

So SA ask price is slightly larger than quoted ask price.

We plug the SA price into the YIELD function, with all other parameters the same as we'd use to calculate ask yield, and the result is an SA yield of 2.37%, which is slightly lower than the ask yield of 2.35%.

The Price SA factor will vary from negative to positive values as the Settlement date CPI SA factor varies relative to the maturity date CPI SA factor, in a fairly regular cycle during the year. The CPI SA factor for any date is the ratio of non-seasonally adjusted to seasonally adjusted reference CPI values for that date. Note that I use this ratio directly, so I show the SA factors as X.XXXXX, but BLS multiplies the ratio by 100. This doesn't matter in the calculations, because we're taking the ratio of two SA factors. Here is a chart of CPI SA factors by date:



Note that these are the values as published by BLS, so 100 times the values I showed in the example.

We see that SSA mm/dd will be above MSA mm/dd (Feb 15) most of the year, as it is now, so SA price will be higher and SA yield will be lower than the quoted values most of the time. This is because the Feb 15 SA factor is much closer to the lowest SA value than it is to the highest.

A much more important observation is that at shorter maturities, seasonality causes a sawtooth type pattern in the quoted yields. If we weren't aware of this effect, and made our purchase decisions based only on quoted yields, we'd end up with different maturities for rungs for which there are more than one maturity depending on what time of the year we built our ladder.

I don't recall seeing the residual jaggedness in the SA curve, which is especially noticeable for October maturities, in previous years. I've briefly looked at coupon and index ratio as possible explanatory factors, but I don't see that working in just eyeballing things. Until someone else can explain it, I apply what Paul Canty, the author from whom I learned how to do the calculations, refers to as "outlier factors"; I just enter them into the spreadsheet using trial and error to smooth out the residual jaggedness. I have no idea what the underlying economics might be.

Final note, to give credit where credit is due, #Cruncher derived his own formulas to calculate SA yields some years ago, and I used those until another wonderful forum member pointed me to the Canty paper. #Cruncher's approach is much more complicated, but it's a testament to his work that his results match the Canty results to within a basis point or so of yield.

Hope this helps.

[Retired in CA]

To get deeply into this we should move the discussion to the seasonal adjustments thread, which I linked to above, but here's an answer that may help enough for the purposes of this thread.

Oops. I should read your posts more carefully!

A much more important observation is that at shorter maturities, seasonality causes a sawtooth type pattern in the quoted yields. If we weren't aware of this effect, and made our purchase decisions based only on quoted yields, we'd end up with different maturities for rungs for which there are more than one maturity depending on what time of the year we built our ladder.

I bet a lot of people don't understand this. I certainly didn't when I naively started building my ladder. Luckily, my first rungs are about 5 years out.

Hope this helps.

Definitely! Thank you for taking the time to explain.

[Dufus]

I recently bought some 2034 Tips and will sell some of the 2033 to cover that when the price exceeds what I paid.

What happens if the price never exceeds what you paid?

Either hold to maturity or change my mind sometime between now and then.

[Kevin M]

I’ll bite. I’m a relative newbie and started putting together a TIPS ladder in a fidelity IRa. I bought TIPs on the market. What I’m not sure of is when I did it, how can I be sure that I am buying at the best price? Does fidelity (or vanguard ) let you buy at suboptimal prices.

Question 2

I think this is probably obvious but when building a ladder at positive real rates, do people typically buy a lower face amount the farther you go out, given real rates are positive?

Answer to question 1.

I think in terms of two spreads:

• Bid/ask
• Large/small quantity

There really are two of each of the above, one each for prices and one for yields. Also, each of these spreads can either be expressed as an arithmetic difference (bid-ask) or a percentage difference (ask/bid-1). Of course you could characterize the two listed above as different bid/ask spreads for different quantities, but I don't find this as useful. More on that below.

The bid/ask spread is the difference between the bid and ask yield or price. I think most people usually are thinking of the yield bid/ask, and thinking of it as bid yield minus ask yield. I usually pay no attention to yield bid/ask spreads, especially when I'm just buying, since I've evaluated the spreads periodically, and I know roughly what they are.

What I pay the most attention to when just buying is the large/small-quantity yield spread, since that's the easiest way to eyeball what I'm paying for say quantity 10, compared to institutional investors who are buying quantity 100, 500, or 1,000. At Fido and Vanguard, these spreads can be anywhere from less than a basis point to maybe the high single digits of basis points; if this spread approaches 10 bps, I move on. At Schwab, the highest yield often, if not usually, is for min qty 1, and if it's not, the min qty 1 yield usually is with a basis point of the highest yield. This is one reason I moved all of my accounts from Vanguard and Fidelity to Schwab--I trade lots of Treasuries.

As I discussed in the OP, since late last year I've been doing lots of swaps, where I sell shorter-term TIPS to buy longer-term TIPS. Since I'm going to pay half the bid/ask anyway when I buy, since I buy all of my TIPS on the secondary market, I'm only concerned with the bid/ask for the sale. Also, I'm mainly interested in the price bid/ask percentage spread, calculated as ask/bid-1, since that's the best reflection of the cost. I sold some more Apr 2025s today, so I'll use those as an example.

The price bid/ask-1 for the Apr 2025 today was 0.03% (=97.34970/97.31743-1). I figure that the seller pays half of that, so my cost was 0.015%, which I consider insignificant. Incidentally, the yield bid minus ask was 4 bps (=3.25%-3.21%). All of these values were for min qty 1, so applicable to my relatively small lot size.

Price bid/ask is higher for longer maturities, and yield bid/ask is lower. This is a function of the duration relationship between price and yield. Here's a chart of all TIPS ask/bid-1 price spreads and bid-ask yield spreads:



Note that for the longer maturities that yield bid-ask is less than 1 basis point, while yield ask/bid-1 is as high as 0.14%.

Answer to question 2.

I don't think that this is a useful way to think about it. Unadjusted price depends on yield compared to coupon, and adjusted price also depends on index ratio, aka inflation factor. I assume by face amount that you mean $1,000 unadjusted per bond. A good way to get a sense of what you'd buy for a ladder is to use one of the two TIPS ladder tools mentioned in the OP, and note the quantities you'd buy for each maturity.

Consider the 2052 with cpn 0.125%, yield 2.37%, price 54.574, and index ratio 1.12152, compared to the 2054 with cpn 2.125%, yield 2.39%, price 94.336, and index ratio 1.01727. Using the #Cruncher tool with a DARA of $25K, I'd buy 22 of the 2052s and 24 of the 2054s, so $22K and $24K face respectively. The 2052 delivers 24,673 of real principal at maturity, but costs only 13,474, due to the low coupon and price, while the 2054 delivers 24,414 real principal at maturity, but costs 23,181 due to the higher coupon and price.

The 2054 delivers much of its return in the form of coupons that contribute to the annual real amounts for earlier years, and very little in terms of real price appreciation, while the 2052 delivers much of its return in the form of real principal appreciation, and little in the form of coupons.

[protagonist]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

All that is irrelevant if you hold to maturity, as in BirdFood's example.
If you invest 50K today in TIPS maturing in 2034 at a hypothetical YTM of 2.2%, you are guaranteed a real yield of 2.2% between now and 2034 if you hold to maturity,
If you sell before maturity, like with other bonds, your real yield will be sensitive to interest rate changes. That is why many of us build a TIPS ladder with maturing rungs at least once per year, to minimize the possibility of having to sell prematurely at a bad time.

[watchnerd]

I recently bought some 2034 Tips and will sell some of the 2033 to cover that when the price exceeds what I paid.

What happens if the price never exceeds what you paid?

Either hold to maturity or change my mind sometime between now and then.

I guess I don't understand how your ladder works if you're swapping around like that.

Mine is simple.

I buy rungs for future consumption. I hold them to maturity. At maturity, the income is spent, not rolled.

[protagonist]

Initially I invested all the money I had available for TIPS in a ten year rolling ladder, starting in summer 2022 with mostly 2-4 year maturities, and filling out further as more funds became available from maturing CDs.

I wound up at the end of last year with a balanced ten year ladder with a lot more money than I anticipate needing invested in each rung per year.

Starting in early 2024 I changed strategy (learning from Kevin and others), have been selling excess funds in my earlier rungs ,and using the proceeds to overfund 2034s and 2040s, to eventually fill in the gap years.

I started by selling excess 2024s....worked my way through 25s, 26s and 27s....today I sold some 2028s (due to today's favorable yields) and purchased more 2040s. I now have enough 2034s and almost enough 2040s. Now I have roughly x 25s, 26s, 27s, 28s and 29s. I have almost 2x 30s, 31s, 32s and 33s, about 3.5x 2034s and about 3x 2040s (plus a small amount of 41s and 42s). I will probably increase my proportion of 2040s to 3.5x, which will allow me to eventually lock in favorable yields for the gap years, when available, at x per year, by selling 34s and 40s. I (hope I) will be 88 y.o. in 2040 (I think age is a critical factor in understanding one's TIPS strategy).

I have roughly two rungs maturing each year. My IRA is now 100% TIPS, and my taxable account is roughly 25-30% TIPS. The rest is mostly in the stock market (index fund).
Any excess per year will probably be rolled forward, assuming TIPS remain a favorable investment.

Any feedback about ways to potentially improve my TIPS approach is welcome.

(My primary goal is asset preservation, since I have enough money to fund my retirement and don't think I need more. If I am lucky and the stock market continues to soar, I will also have additional growth.)

[Kevin M]

One thing that has surprised me is the amount of volatility in the month-to-month real rate of a particular issue - the April 2029s, in this case.

There are two Apr 2029s. For some perspective, here's the yield history for the one that's been around much longer:



I don't know what time period you're thinking about, but we see that the volatility of the last year or so isn't particularly remarkable compared to historical volatility--at least that's the way it looks just eyeballing the chart. Since the newer Apr 2029 was just issued in April, how could you be looking at month-to-month volatility for more than a month?

What many of us are excited about is that we're seeing yields that we haven't seen since 2010. And other than the first five years after it was issued in 1999, and a brief spike from late 2008 to mid-2009, the yields we're seeing now are at or above historical levels.

Note that the yields of both Apr 2029s are about the same, as they have been since the new one was issued, and they probably will remain so. Here is the yield history since 4/18/2024, the date of the most recent 5y auction, through last Friday:



Note that the auction yield was 2.24%, and the yield when I looked today was 2.27% for the new one and 2.28% for the old one. The high yield I see on the chart is 2.28% and the low is 2.05% on May 15. I guess an increase of more than 20 basis points in half a month--back to the recent high--is pretty nice; I actually bought some of the new one today at 2.27% (with proceeds from selling some of my Apr 2025s), so I obviously was pleased by the recent increase in yields.

[Kevin M]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

Lots of confusion here, wellboy99. If you want to converse about TIPS, it might be worth investing some effort in learning how TIPS actually work. Birdfood has provided some useful info to get you started.

As to the last point, not so much. Here's a chart of the yield of a TIPS issued in 1999, and the year over year change in CPI:



I've put each on a different vertical axis, since the magnitude difference in CPI are so much larger than that of the TIPS yield. We see that sometimes they kind of move together, but other times not at all.

Here are some accurate statements that might help.

• Bond yield and price are inversely related. This is true of TIPS as it is for all other bonds. So yeah, if real yield increases, TIPS unadjusted price decreases, and vice versa.
• The magnitude of price change relative to yield change is larger for longer term bonds--again, true for all bonds. Technically, it's duration that matters more than term to maturity, but that's a fine point that we can put aside for now.
• If you hold to maturity, the interim changes in unadjusted price simply don't matter. You know the bond will mature at a price of 100, so you know exactly what you'll get in real terms at maturity.
• I qualified "price" with "unadjusted", because the price you actually pay or receive--the adjusted price--is adjusted based on the change in the reference CPI since the dated date of the TIPS (hmm, I think there might be more to explain than I can put in a reasonably short bulleted list, but here's a bit more.)
• The dated date for TIPS is the 15th of the month it's first issued, which is toward the end of the month.
• The reference CPI values used to adjust the TIPS prices lag the published CPI values by about three months. This is a very rough approximation to the reality, but good enough for now.
• So, if you hold to maturity, you know with almost no uncertainty what the internal rate of return (IRR) of the cash flows will be.
• The IRR may not equal the realized return if you're reinvesting the coupons (interest payments), because of the uncertainty in reinvestment rates.
• If you build a ladder of TIPS with the goal of generating a Desired Annual Real Amount (DARA) each year, you know with high certainty that the ladder will deliver the DARA each year. You don't care about coupon reinvestment rate, because the coupons are part of the DARA; i.e., you spend them along with the principal of any TIPS that mature that year.

If you understand all of this, you'll understand that "buying a TIPS ladder", as most of us do it, is most definitely not a losing game. We don't think of it as a game at all, but as a way to provide a relatively certain floor of safe, real (inflation adjusted) income in retirement. And IMO, there is no better way to do that, although you can do something similar with TIPS funds, so a TIPS ladder is not the only game in town.

[Dufus]

I recently bought some 2034 Tips and will sell some of the 2033 to cover that when the price exceeds what I paid.

What happens if the price never exceeds what you paid?

Either hold to maturity or change my mind sometime between now and then.

I guess I don't understand how your ladder works if you're swapping around like that.

Mine is simple.

I buy rungs for future consumption. I hold them to maturity. At maturity, the income is spent, not rolled.

Hi Watchnerd, My intention is also to hold MOST of my rungs to maturity. I overloaded 2033 and 2040 to cover for the fact that there were no TIPS for those "Missing Years". When 2034s became available, I bought some. Now I don't need as much overage in 2033s. I will probably end up selling the extra and moving it into equities. I am guessing that if the market tanks at some point the value of the extra TIPS will rise. That might be a good time to sell the extra and buy equities while they are down. If the market doesn't tank, I'll probably let the extra sit where it is, unless I decide I want to convert some more to Roth.

[KMoney]

I want to add TIPS to my portfolio in the future but still can’t convince myself I fully understand how TIPS funds behave.

When I look at portfolio visualizer I see that Vanguards short term TIPS fund was losing value around 2014-2015 while both short term nominal funds and BND were gaining value.

I would expect nominal funds to outperform TIPS funds when inflation is low but can’t articulate why the funds values would move in opposite directions.

[Kevin M]

I want to add TIPS to my portfolio in the future but still can’t convince myself I fully understand how TIPS funds behave.

When I look at portfolio visualizer I see that Vanguards short term TIPS fund was losing value around 2014-2015 while both short term nominal funds and BND were gaining value.

I would expect nominal funds to outperform TIPS funds when inflation is low but can’t articulate why the funds values would move in opposite directions.

This is actually pretty easy to understand.

First, let's agree that breakeven inflation (BEI) is a decent proxy for expected inflation. BEI is the nominal yield minus the real yield for the maturity of interest. There are a couple of dominant premiums involved in BEI relative to expected inflation, but they are not observable, and work in the opposite directions, so I ignore them for first approximation purposes.

Let's look at an example for a maturity of about five years. The yield of the 7/15/2029 TIPS right now is 2.10%. There is no 7/15/2029 nominal, so I'll use the 6/30/2029 nominal at a yield now of 4.60%. The BEI is 4.60%-2.10% = 2.50%. I believe that the more accurate way to calculate it is (1+n)/(1+t) - 1, which comes to 2.45%, but I think most people use the arithmetic subtraction method. Either way, BEI is about 2.5 percentage points.

If we buy a nominal bond and a TIPS of the same maturity, the nominal will outperform if inflation is lower than expected, and the TIPS will outperform if inflation is higher than expected. This is a truism, since that's pretty much the definition of "breakeven inflation". Also, one of the values of TIPS is to protect against unexpected inflation. Note that the expected return is about the same for TIPS and nominals of the same maturity.

Funds are little more complicated because of the multiple holdings, so we can't compare funds as precisely as we can compare individual bonds. Still, the general concept should apply pretty well for funds of similar duration (you can't really compare a long-term TIPS fund to a short-term nominal bond fund).

So, to analyze the relative performance, you'd need to determine the BEI at the start of the holding period, and see if realized inflation relative to initial BEI explains the differences.

[Kevin M]

After two pretty big down days for LTPZ, in terms of price, today is a pretty big up day. Here's what I see in my handy dandy ETF snapshot spreadsheet:



We see that LTPZ, third from the bottom, currently is up 0.66% relative to yesterday's close. Of course this means that long-term TIPS yields will be down a bit today.

Looking at Schwab ask yields, the 2046/47/48 are at 2.36%, and we saw them at 2.41% yesterday. Still a pretty decent yield relative to what we've seen over the last year. Here's the 2047 from 5/29/2023-5/29/2024:

[well9boy9]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

Lots of confusion here, wellboy99. If you want to converse about TIPS, it might be worth investing some effort in learning how TIPS actually work. Birdfood has provided some useful info to get you started.

As to the last point, not so much. Here's a chart of the yield of a TIPS issued in 1999, and the year over year change in CPI:



I've put each on a different vertical axis, since the magnitude difference in CPI are so much larger than that of the TIPS yield. We see that sometimes they kind of move together, but other times not at all.

Here are some accurate statements that might help.

• Bond yield and price are inversely related. This is true of TIPS as it is for all other bonds. So yeah, if real yield increases, TIPS unadjusted price decreases, and vice versa.
• The magnitude of price change relative to yield change is larger for longer term bonds--again, true for all bonds. Technically, it's duration that matters more than term to maturity, but that's a fine point that we can put aside for now.
• If you hold to maturity, the interim changes in unadjusted price simply don't matter. You know the bond will mature at a price of 100, so you know exactly what you'll get in real terms at maturity.
• I qualified "price" with "unadjusted", because the price you actually pay or receive--the adjusted price--is adjusted based on the change in the reference CPI since the dated date of the TIPS (hmm, I think there might be more to explain than I can put in a reasonably short bulleted list, but here's a bit more.)
• The dated date for TIPS is the 15th of the month it's first issued, which is toward the end of the month.
• The reference CPI values used to adjust the TIPS prices lag the published CPI values by about three months. This is a very rough approximation to the reality, but good enough for now.
• So, if you hold to maturity, you know with almost no uncertainty what the internal rate of return (IRR) of the cash flows will be.
• The IRR may not equal the realized return if you're reinvesting the coupons (interest payments), because of the uncertainty in reinvestment rates.
• If you build a ladder of TIPS with the goal of generating a Desired Annual Real Amount (DARA) each year, you know with high certainty that the ladder will deliver the DARA each year. You don't care about coupon reinvestment rate, because the coupons are part of the DARA; i.e., you spend them along with the principal of any TIPS that mature that year.

If you understand all of this, you'll understand that "buying a TIPS ladder", as most of us do it, is most definitely not a losing game. We don't think of it as a game at all, but as a way to provide a relatively certain floor of safe, real (inflation adjusted) income in retirement. And IMO, there is no better way to do that, although you can do something similar with TIPS funds, so a TIPS ladder is not the only game in town.

Thank you all for helping me understand.

[#Cruncher]

Question 2
... when building a ladder at positive real rates, do people typically buy a lower face amount the farther you go out, given real rates are positive?

No. Typically purchasers want the same amount in today's purchasing power for each rung of the ladder. For example, assume one wants $100K in today's dollars each of the years 2026, 2032, and 2052 and one is considering the following three TIPS for these three rungs:

• Column B: 0-1/8% 10-year TIPS maturing 7/15/2026 issued July 2016
• Column C: 0-1/8% 10-year TIPS maturing 1/15/2032 issued January 2022
• Column D: 0-1/8% 30-year TIPS maturing 2/15/2052 issued February 2022

Row 11 of the following table shows that (ignoring the effect of coupon interest) one would need to purchase $77,000 face value of the July 2026 and $89,000 face value of the Jan 2032 and Feb 2052. One needs less of the July 2026 because it was issued earlier than the other two and its principal value has had longer to grow with inflation. The Jan 2032 and Feb 2052 maturities were both first issued near the start of 2022 and therefore have about the same growth in inflation-adjusted principal.

Code: Select all

Row              Col A      Col B      Col C      Col D   Formula in Column B Copied Right
  2  Desired principal    100,000
  3              Today  5/30/2024
  4      Reference CPI  312.20258
  5       Bond matures  7/15/2026  1/15/2032  2/15/2052
  6             Coupon     0.125%     0.125%     0.125%
  7              Price   95+12/32   85+25/32   55+22/32 [*]
  8         Dated Date  7/15/2016  1/15/2022  2/15/2022
  9      Reference CPI  239.70132  277.20274  278.37500
 10        Index ratio    1.30247    1.12626    1.12152  =ROUND($B4/B9,5)
 11         Face value     77,000     89,000     89,000  =ROUND($B2/B10,-3)
 12               Cost     95,652     85,985     55,585  =B11*B10*(B7/100)
 13              Yield     2.368%     2.157%     2.295%  =YIELD($B3,B5,B6,B7,100,2,1) [*] 

Where you see the effect of the 2+% yield is in the cost shown on row 12. Since all three have the same 0-1/8% coupon which is well below the yield, the cost will be less the longer each bond has until maturity. If they each had coupons equal to their yield, they each would cost about $100K.

... The yield of the 7/15/2029 TIPS right now is 2.10%. ... the 6/30/2029 nominal [has] a yield now of 4.60%. The BEI is 4.60%-2.10% = 2.50%. I believe that the more accurate way to calculate it is (1-n)/(1-t) - 1, which comes to 2.45% ... (underline added)

You made a typo here, Kevin. It should be "(1+n)/(1+t) - 1", which does come to 2.45% (1.046 / 1.021 - 1).

* Prices on row 7 are from Thursday's WSJ TIPS Quotes. Yields on row 13 are computed with the Excel YIELD function.

[Kevin M]

LTPZ is up more today than it was when I checked it yesterday morning. As of now the change from yesterday's close is +0.80%. So we'd expect long-term TIPS yields to be down.

Sure enough, the high 204X yields now are 2.31% for the 2046/47/48, down 5 basis points from when I checked yesterday.

The three short-term TIPS funds I have in my market quotes sheet, VTIP, STPZ and STIP, are all up +0.16%. The price and yield of the Apr 2028 I bought three days ago at 96.0054/2.33% are 96.26182/2.27%, so 0.27% more expensive for a 6 bps decline in yield.

During the time I've been writing this, LTPZ price has increased, and now is up 0.88%.

[Kevin M]

The price and yield of the Apr 2028 I bought three days ago at 96.0054/2.33% are 96.26182/2.27%, so 0.27% more expensive for a 6 bps decline in yield.

Closing the loop on this, I decided to sell some Apr 2025 and buy some more Apr 2028 @ Yield = 2.28%, price = 96.1915. Principal per $10K face = 10,018.82, which is $28.11 or about 0.28% more than the 9,990.71 principal per $10K face I paid three days ago.

LTPZ now is up 0.45% since yesterday, so it's fallen quite a bit from the high of +0.90% I saw at one point.

[BirdFood]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?
- Therefore, if I'm buying these on the assumption that Treasury yields are going to go down, it will be problematic to reinvest the coupon at the same rate and the same level of safety, so that I can regard the yield as meaningful?
- Therefore, I would be better off--no, I would have a SIMPLER problem--if I seek minimum coupon associated with corresponding price discount?
- So that I'll get my money later, but that's built into the yield calculation and in theory, I end up the same in the end? I realize that it depends on precisely what I buy and the price that minute; I mean, the tendency is that low coupon may get a discount, high coupon may get a premium, and the yield calculation's precise job is to tell me whether I end up even?

I have been assuming these things, but it seems like I should make sure.

Oh, and of course there's the adjusted principal and how I feel about that, the odds of deflation, and how it will affect me in the case of deflation. But the yield has nothing to say about that, I believe.

[dbr]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?

YTM assumes nothing about what the investor does with the coupon payments. However, if you want to compute return and include in your return at the end the earnings gained on the coupons wherever they are then invested, then you are going to have to track those investments and what they earn. Keep in mind that if this money is invested somewhere that pays away interest that is then in turn invested somewhere you have to track and add that in and on and on. If you don't reinvest the coupon payments then your holding has cash flow withdrawals and the concept of return must be abandoned in favor or internal rate of return or time weighted average return. YTM is really the same as or similar to an internal rate of return rather than a (total) return.

[RationalWalk]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?

YTM assumes nothing about what the investor does with the coupon payments. However, if you want to compute return and include in your return at the end the earnings gained on the coupons wherever they are then invested, then you are going to have to track those investments and what they earn. Keep in mind that if this money is invested somewhere that pays away interest that is then in turn invested somewhere you have to track and add that in and on and on. If you don't reinvest the coupon payments then your holding has cash flow withdrawals and the concept of return must be abandoned in favor or internal rate of return or time weighted average return. YTM is really the same as or similar to an internal rate of return rather than a (total) return.

Thanks for that explanation. Helps clarify for me how to think about the coupons. It's my preference to buy TIPs with a low coupon so that most of the return is principal, getting close as possible to a zero coupon bond. With these higher coupons now; e.g., 2% it looks like most of the bonus to inflation is spun off as coupon payments. Unless you're managing those to maturity date, what you're getting at maturity in principal return is close to 0% real return. The coupon payments can get commingled along the way and probably spent. Am I right?

[hudson]

I feel buying TIPS ladder is a sure losing game.

If inflation goes up, your holding loses value in the secondary market.

Do you mean if interest goes up?

And you’re assuming that value in the secondary market is relevant. If you bought to hold to maturity, it’s not relevant.

If inflation goes down, your yield + inflation rate is smaller. The inflation protection aspect is eroded.

Please correct my (wrong ?)

And do you mean if interest goes down? Or inflation?

If inflation is low, TIPS may be outperformed by nominal bonds, yes. But they will still earn a specific real yield.

I don’t understand your argument.

Returning to add:

Let’s say that I have 50K today and I’d like to be SURE that I’m transporting that 50K of buying power to 2034. Ultra, totally sure. That is a higher priority for me than taking a gamble on maximizing the return on that 50K. I’d like to grow its buying power, but my main priority is to preserve the buying power it has.

That’s what TIPS will do.

I would think inflation rate and interest rate typically are locked step by step. When inflation goes up, interest rate goes up, and vice versa.

Lots of confusion here, wellboy99. If you want to converse about TIPS, it might be worth investing some effort in learning how TIPS actually work. Birdfood has provided some useful info to get you started.

As to the last point, not so much. Here's a chart of the yield of a TIPS issued in 1999, and the year over year change in CPI:



I've put each on a different vertical axis, since the magnitude difference in CPI are so much larger than that of the TIPS yield. We see that sometimes they kind of move together, but other times not at all.

Here are some accurate statements that might help.

• Bond yield and price are inversely related. This is true of TIPS as it is for all other bonds. So yeah, if real yield increases, TIPS unadjusted price decreases, and vice versa.
• The magnitude of price change relative to yield change is larger for longer term bonds--again, true for all bonds. Technically, it's duration that matters more than term to maturity, but that's a fine point that we can put aside for now.
• If you hold to maturity, the interim changes in unadjusted price simply don't matter. You know the bond will mature at a price of 100, so you know exactly what you'll get in real terms at maturity.
• I qualified "price" with "unadjusted", because the price you actually pay or receive--the adjusted price--is adjusted based on the change in the reference CPI since the dated date of the TIPS (hmm, I think there might be more to explain than I can put in a reasonably short bulleted list, but here's a bit more.)
• The dated date for TIPS is the 15th of the month it's first issued, which is toward the end of the month.
  
• The reference CPI values used to adjust the TIPS prices lag the published CPI values by about three months. This is a very rough approximation to the reality, but good enough for now.
• So, if you hold to maturity, you know with almost no uncertainty what the internal rate of return (IRR) of the cash flows will be.
• The IRR may not equal the realized return if you're reinvesting the coupons (interest payments), because of the uncertainty in reinvestment rates.
• If you build a ladder of TIPS with the goal of generating a Desired Annual Real Amount (DARA) each year, you know with high certainty that the ladder will deliver the DARA each year. You don't care about coupon reinvestment rate, because the coupons are part of the DARA; i.e., you spend them along with the principal of any TIPS that mature that year.

If you understand all of this, you'll understand that "buying a TIPS ladder", as most of us do it, is most definitely not a losing game. We don't think of it as a game at all, but as a way to provide a relatively certain floor of safe, real (inflation adjusted) income in retirement. And IMO, there is no better way to do that, although you can do something similar with TIPS funds, so a TIPS ladder is not the only game in town.

Thanks!
Great and most useful review for the advance novice!
Bookmarked.
More detail on the bolded statement above from #Cruncher:
viewtopic.php?p=7839572#p7839572

[dbr]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?

YTM assumes nothing about what the investor does with the coupon payments. However, if you want to compute return and include in your return at the end the earnings gained on the coupons wherever they are then invested, then you are going to have to track those investments and what they earn. Keep in mind that if this money is invested somewhere that pays away interest that is then in turn invested somewhere you have to track and add that in and on and on. If you don't reinvest the coupon payments then your holding has cash flow withdrawals and the concept of return must be abandoned in favor or internal rate of return or time weighted average return. YTM is really the same as or similar to an internal rate of return rather than a (total) return.

Thanks for that explanation. Helps clarify for me how to think about the coupons. It's my preference to buy TIPs with a low coupon so that most of the return is principal, getting close as possible to a zero coupon bond. With these higher coupons now; e.g., 2% it looks like most of the bonus to inflation is spun off as coupon payments. Unless you're managing those to maturity date, what you're getting at maturity in principal return is close to 0% real return. The coupon payments can get commingled along the way and probably spent. Am I right?

No, there is still return but the timing is complicated. That is why notions such as IRR and TWR are invoked. And there is no reason to presume that the interest payments are spent. A person can easily direct them to a money market fund or something and they are still invested, or you can add them to money that gets invested in about anything. It really is not that big a deal except when you are trying to an analyze return from an investment like that down to the nit and then come into some definitional problems. YTM remains perfectly well defined without regard for coupon payments. From a practical point of view it all just goes to some allocation or another in the portfolio. It is true, however, that the whole thing can be end run by just holding a bond fund with auto reinvested dividends. But people have smeared such a black mark on bond funds that they would rather do anything than hold a bond fund.

Note return is a rate in time of a ratio. The ratio is dollars gained per dollar and the rate is dollars/dollar/time (for example % PA). So time matters. This is not a complication when all the cash flow is restricted to dollars in at a start and dollars out at a finish. But when dollars are added or removed at arbitrary times along the way the definitions that are meaningful get more complicated.

[Johnnie]

One thing that has surprised me is the amount of volatility in the month-to-month real rate of a particular issue - the April 2029s, in this case.

There are two Apr 2029s. For some perspective, here's the yield history for the one that's been around much longer:


Here is the yield history since 4/18/2024, the date of the most recent 5y auction, through last Friday:



Note that the auction yield was 2.24%, and the yield when I looked today was 2.27% for the new one and 2.28% for the old one. The high yield I see on the chart is 2.28% and the low is 2.05% on May 15. I guess an increase of more than 20 basis points in half a month--back to the recent high--is pretty nice...

Yes, that's what I'm talking about re. surprising volatility, "more than 20 basis points in half a month" - on a real-rate range of 2.05% to 2.28%. That's a 10% move in the real rate in just two weeks. It seems like a lot. Maybe this is just a consequence of looking only at the real rate, vs looking at the current 4.50 rate on a "regular" five year bond.
I'm noticing because I'm looking to increase my holdings in this issue at the June 20 "reopening" auction.

[Johnnie]

One thing that has surprised me is the amount of volatility in the month-to-month real rate of a particular issue - the April 2029s, in this case.

There are two Apr 2029s. For some perspective, here's the yield history for the one that's been around much longer:


Here is the yield history since 4/18/2024, the date of the most recent 5y auction, through last Friday:



Note that the auction yield was 2.24%, and the yield when I looked today was 2.27% for the new one and 2.28% for the old one. The high yield I see on the chart is 2.28% and the low is 2.05% on May 15. I guess an increase of more than 20 basis points in half a month--back to the recent high--is pretty nice...

Yes, that's what I'm talking about re. "surprising" volatility, "more than 20 basis points in half a month" - on a real-rate range in the low 2-percents. That's a 10% move in the real rate in just two weeks. It seems like a lot. Maybe this is just a consequence of looking only at the real rate, vs looking at the current 4.50 rate on a "regular" five year bond.
I'm noticing because I'm looking to increase my holdings in this issue at the June 20 "reopening" auction.

[B88]

Glad to see the topic of seasonally adjusted yields. I found out about that effect the hard way. Buying some short term TIPS on the secondary market. Didn't get the total yield in the end I was expecting partly due to this seasonal effect. Worked out okay in the end just not as well as I thought it would.

[RationalWalk]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?

YTM assumes nothing about what the investor does with the coupon payments. However, if you want to compute return and include in your return at the end the earnings gained on the coupons wherever they are then invested, then you are going to have to track those investments and what they earn. Keep in mind that if this money is invested somewhere that pays away interest that is then in turn invested somewhere you have to track and add that in and on and on. If you don't reinvest the coupon payments then your holding has cash flow withdrawals and the concept of return must be abandoned in favor or internal rate of return or time weighted average return. YTM is really the same as or similar to an internal rate of return rather than a (total) return.

Thanks for that explanation. Helps clarify for me how to think about the coupons. It's my preference to buy TIPs with a low coupon so that most of the return is principal, getting close as possible to a zero coupon bond. With these higher coupons now; e.g., 2% it looks like most of the bonus to inflation is spun off as coupon payments. Unless you're managing those to maturity date, what you're getting at maturity in principal return is close to 0% real return. The coupon payments can get commingled along the way and probably spent. Am I right?

No, there is still return but the timing is complicated. That is why notions such as IRR and TWR are invoked. And there is no reason to presume that the interest payments are spent. A person can easily direct them to a money market fund or something and they are still invested, or you can add them to money that gets invested in about anything. It really is not that big a deal except when you are trying to an analyze return from an investment like that down to the nit and then come into some definitional problems. YTM remains perfectly well defined without regard for coupon payments. From a practical point of view it all just goes to some allocation or another in the portfolio. It is true, however, that the whole thing can be end run by just holding a bond fund with auto reinvested dividends. But people have smeared such a black mark on bond funds that they would rather do anything than hold a bond fund.

Note return is a rate in time of a ratio. The ratio is dollars gained per dollar and the rate is dollars/dollar/time (for example % PA). So time matters. This is not a complication when all the cash flow is restricted to dollars in at a start and dollars out at a finish. But when dollars are added or removed at arbitrary times along the way the definitions that are meaningful get more complicated.

I'm still confused about it. Let's say my objective is to purchase a TIPs ladder that will generate equal real dollars each year, $x. What I'm expecting is that when each TIP matures, $x (real) will show up in my brokerage reserve account for me to spend that year. Ideally, each TIP would be a zero coupon and that's what would happen. The Tipsladder app illustrates what happens instead. It gives me the option of including or not including the coupon payments in determining how many TIPs to buy for each rung. In order to be able to see $x (real) pop up each year in my brokerage reserve fund (as each TIP matures) I decide to NOT include the coupon payments in the analysis. I'll just let the coupon payments spin off somewhere because I just don't want to have keep track of them and manage them so that in each year I'm getting equal real total dollars to spend that year (principal + accumulated coupons). Too much fuzz. What's the point of having a TIPs ladder if each maturing rung doesn't automatically dump the level spending power I wanted into my spending account? I realize that this approach causes me to buy more TIPs than I need to, especially for rungs with larger coupons such as is happening now with new TIPs. Actually, it is this realization that keeps me away from purchasing some TIPs with higher coupons.

I guess I'm trying to determine if my perspective is rational or if I don't get it.

[BirdFood]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?

YTM assumes nothing about what the investor does with the coupon payments. However, if you want to compute return and include in your return at the end the earnings gained on the coupons wherever they are then invested, then you are going to have to track those investments and what they earn. Keep in mind that if this money is invested somewhere that pays away interest that is then in turn invested somewhere you have to track and add that in and on and on. If you don't reinvest the coupon payments then your holding has cash flow withdrawals and the concept of return must be abandoned in favor or internal rate of return or time weighted average return. YTM is really the same as or similar to an internal rate of return rather than a (total) return.

Thank you! I'm glad I was mistaken.

Googling, I was vaguely reassured to learn that I'm not the only one who, erroneously, thought this. I found a page that offers a number of sources on "the reinvestment fallacy."

https://money.stackexchange.com/questio ... 116#155116

[dbr]

[quo
I'm still confused about it. Let's say my objective is to purchase a TIPs ladder that will generate equal real dollars each year, $x. What I'm expecting is that when each TIP matures, $x (real) will show up in my brokerage reserve account for me to spend that year. Ideally, each TIP would be a zero coupon and that's what would happen. The Tipsladder app illustrates what happens instead. It gives me the option of including or not including the coupon payments in determining how many TIPs to buy for each rung. In order to be able to see $x (real) pop up each year in my brokerage reserve fund (as each TIP matures) I decide to NOT include the coupon payments in the analysis. I'll just let the coupon payments spin off somewhere because I just don't want to have keep track of them and manage them so that in each year I'm getting equal real total dollars to spend that year (principal + accumulated coupons). Too much fuzz. What's the point of having a TIPs ladder if each maturing rung doesn't automatically dump the level spending power I wanted into my spending account? I realize that this approach causes me to buy more TIPs than I need to, especially for rungs with larger coupons such as is happening now with new TIPs. Actually, it is this realization that keeps me away from purchasing some TIPs with higher coupons.

I guess I'm trying to determine if my perspective is rational or if I don't get it.

I don't do bond ladders and don't look in detail at the ladder tools, but for me the basic idea would presumably be that your income each year is the proceeds of the maturing rung that year plus the total of all the coupon payments from all the still existing bonds. So a ladder calculator would tabulate all that and tell you an amount that will automatically be deposited in known in advance real dollars in your spending account.

So what is wrong with that if the tool can handle the bookkeeping?

[watchnerd]

So, I'm looking at long term secondary market TIPS. Questions:

- My understanding is that the yield assumes that the coupon is reinvested at the same rate as the TIPS?

YTM assumes nothing about what the investor does with the coupon payments. However, if you want to compute return and include in your return at the end the earnings gained on the coupons wherever they are then invested, then you are going to have to track those investments and what they earn. Keep in mind that if this money is invested somewhere that pays away interest that is then in turn invested somewhere you have to track and add that in and on and on. If you don't reinvest the coupon payments then your holding has cash flow withdrawals and the concept of return must be abandoned in favor or internal rate of return or time weighted average return. YTM is really the same as or similar to an internal rate of return rather than a (total) return.

Thanks for that explanation. Helps clarify for me how to think about the coupons. It's my preference to buy TIPs with a low coupon so that most of the return is principal, getting close as possible to a zero coupon bond. With these higher coupons now; e.g., 2% it looks like most of the bonus to inflation is spun off as coupon payments. Unless you're managing those to maturity date, what you're getting at maturity in principal return is close to 0% real return. The coupon payments can get commingled along the way and probably spent. Am I right?

No, there is still return but the timing is complicated. That is why notions such as IRR and TWR are invoked. And there is no reason to presume that the interest payments are spent. A person can easily direct them to a money market fund or something and they are still invested, or you can add them to money that gets invested in about anything. It really is not that big a deal except when you are trying to an analyze return from an investment like that down to the nit and then come into some definitional problems. YTM remains perfectly well defined without regard for coupon payments. From a practical point of view it all just goes to some allocation or another in the portfolio. It is true, however, that the whole thing can be end run by just holding a bond fund with auto reinvested dividends. But people have smeared such a black mark on bond funds that they would rather do anything than hold a bond fund.

Note return is a rate in time of a ratio. The ratio is dollars gained per dollar and the rate is dollars/dollar/time (for example % PA). So time matters. This is not a complication when all the cash flow is restricted to dollars in at a start and dollars out at a finish. But when dollars are added or removed at arbitrary times along the way the definitions that are meaningful get more complicated.

I'm still confused about it. Let's say my objective is to purchase a TIPs ladder that will generate equal real dollars each year, $x. What I'm expecting is that when each TIP matures, $x (real) will show up in my brokerage reserve account for me to spend that year. Ideally, each TIP would be a zero coupon and that's what would happen. The Tipsladder app illustrates what happens instead. It gives me the option of including or not including the coupon payments in determining how many TIPs to buy for each rung. In order to be able to see $x (real) pop up each year in my brokerage reserve fund (as each TIP matures) I decide to NOT include the coupon payments in the analysis. I'll just let the coupon payments spin off somewhere because I just don't want to have keep track of them and manage them so that in each year I'm getting equal real total dollars to spend that year (principal + accumulated coupons). Too much fuzz. What's the point of having a TIPs ladder if each maturing rung doesn't automatically dump the level spending power I wanted into my spending account? I realize that this approach causes me to buy more TIPs than I need to, especially for rungs with larger coupons such as is happening now with new TIPs. Actually, it is this realization that keeps me away from purchasing some TIPs with higher coupons.

I guess I'm trying to determine if my perspective is rational or if I don't get it.

I don't bother with a ladder tool, either.

I just buy them as if they're zero coupon. A lot of the TIPS I own have coupons so low they're almost zero coupon, anyway.

[dbr]

I don't bother with a ladder tool, either.

I just buy them as if they're zero coupon. A lot of the TIPS I own have coupons so low they're almost zero coupon, anyway.

I imagine the more complicated finagle for a long ladder is finding all the needed maturities of TIPS.

But, I have never contemplated actually using a TIPS ladder and have not looked in detail how it is done in practice.

[gips]

Hi kevin, thanks for starting this thread! Do you plan to hold tips in taxable? I’ve run out of pretax space and have been thinking about it.

[#Cruncher]

Kevin M intends this thread to be a catch-all for topics not elsewhere covered. It might be better to post new questions about the tipsladder.com tool in its dedicated thread, New tool for building a TIPS ladder.

... The Tipsladder app illustrates what happens instead. It gives me the option of including or not including the coupon payments in determining how many TIPs to buy for each rung.

You're missing "pre-ladder" from the option, "[ ] Exclude pre-ladder interest from ladder's early rungs" on the tipsladder.com entry page. If your ladder begins in 2025 and you check this box, only the interest collected in 2024 will be ignored. (If you don't check the box, that interest will be used to reduce the number of bonds needed in 2025.)

I'll just let the coupon payments spin off somewhere because I just don't want to have keep track of them and manage them so that in each year I'm getting equal real total dollars to spend that year (principal + accumulated coupons). ... What's the point of having a TIPs ladder if each maturing rung doesn't automatically dump the level spending power I wanted into my spending account?

You're worrying about a non-existent problem, RationalWalk. dbr's understanding above is correct. Both the tipsladder.com tool and my TIPS Ladder Builder Excel workbook include coupons in the annual cash flow. You don't need to do anything with them except spend them along with whatever principal is collected. [*] For example, the following table shows the default ladder's cash flow each year from the "Yearly" sheet of my Excel workbook. Note that each year except 2034-2040 [*] approximately 30,000 of June 2024 dollars is collected. It is composed of 1) the principal of the bond maturing that year, 2) that bond's final year interest payment(s), and 3) interest collected on all bonds maturing in later years.

I realize that this approach causes me to buy more TIPs than I need to, especially for rungs with larger coupons such as is happening now with new TIPs. Actually, it is this realization that keeps me away from purchasing some TIPs with higher coupons.

For the reason explained above, there is no need to avoid higher coupon TIPS.

Code: Select all

                        --- Proceeds in Jun 3 2024 Dollars ---
         Nbr                        Final    Coupons     Total
 Year  Bonds      Cost  Principal  Coupon  Oth Bonds  Proceeds

Code: Select all

 2025     18    21,196     21,771      14      8,338    30,122
 2026     18    20,488     21,443      13      8,311    29,767
 2027     19    19,719     21,023      13      8,284    29,321
 2028     21    21,075     21,873     137      8,011    30,020
 2029     23    23,246     23,231     247      7,517    30,995
 2030     18    19,586     21,857      14      7,490    29,361
 2031     19    20,042     22,802      14      7,462    30,278
 2032     20    19,389     22,540      14      7,433    29,988
 2033     21    20,372     22,025     124      7,186    29,334
 2034     52    51,389     52,850     462      6,261    59,573
 2035                                          6,261     6,261
 2036                                          6,261     6,261
 2037                                          6,261     6,261
 2038                                          6,261     6,261
 2039                                          6,261     6,261
 2040     79   113,238    114,188   1,213      3,834   119,236
 2041     19    26,905     27,105     288      3,258    30,652
 2042     19    20,475     26,269      99      3,061    29,429
 2043     20    20,357     27,177      85      2,891    30,153
 2044     20    23,016     26,810     184      2,523    29,517
 2045     21    20,819     27,861     104      2,314    30,279
 2046     21    21,542     27,689     138      2,037    29,864
 2047     22    21,313     28,473     125      1,788    30,385
 2048     22    21,249     27,872     139      1,509    29,520
 2049     24    22,586     29,797     149      1,211    31,157
 2050     23    16,930     27,949      35      1,141    29,125
 2051     24    16,516     28,799      18      1,105    29,922
 2052     26    16,424     29,179      18      1,069    30,266
 2053     28    24,686     29,428     221        627    30,276
 2054     29    28,703     29,521     314               29,834

Code: Select all

Total    626   651,261    759,531   4,182    135,965   899,678

* No TIPS currently mature in 2035-2039. By default, my ladder builder purchases extra amounts of the bonds maturing in 2034 and 2040 to cover this gap. Extra work is required to collect 30,000 real dollars these years. One way would be to replace some of the extra 2034 or 2040 maturities each year 2025-2029 with newly issued 10-year TIPS.

[Kevin M]

Hi kevin, thanks for starting this thread! Do you plan to hold tips in taxable? I’ve run out of pretax space and have been thinking about it.

DW and I currently hold all of our TIPS in our IRAs, but I've bought TIPS in taxable for family and friends whose accounts I manage.

Holding TIPS in tax-deferred accounts probably is more tax efficient, since you can reinvest the coupons without being taxed on them in the year of the coupon payment. OTOH, you lose the state income tax exemption. I don't recall ever doing the analysis of one vs. the other.

Holding TIPS in a Roth is the most tax efficient way, but most people here seem to prefer holding stocks in their Roths. I think much of that sentiment is due to a misunderstanding of the risk-adjusted expected returns; i.e., where you hold something changes the after-tax risk, and when that is factored in, the advantage of holding riskier assets with higher expected returns in Roth is minimal. But let's not digress into this too much please.

If you don't have the tax-advantages space, or you don't want to hold TIPS there for whatever reason, then your only choice is taxable. I think the benefits of TIPS outweigh the tax disadvantages. If you think of the inflation adjustments as forced dividend reinvestments, TIPS are no more tax inefficient than nominal bonds.

A friend whose accounts I manage has some IRA space, but not enough, so I've put most of the longer term TIPS in the IRA, to benefit the most from deferring income taxes on the TIPS portfolio.

If you want to dig into the tax aspects, please post questions in Taxation of Treasury bills, notes and bonds - Bogleheads.org.