Thoughts on using an ETF for TIPS investing

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
PalmQueen
Posts: 3
Joined: Sun Jul 08, 2018 6:09 pm

Thoughts on using an ETF for TIPS investing

Post by PalmQueen » Wed Jul 11, 2018 6:46 pm

Greetings - Currently, the "fixed income position" in my portfolio consists of money market accounts. I'm tempted to leave it there now that interest rates are on the rise but also feel there are other options which would provide better returns which also have low risk. Hence, I'm looking at ETFs that invest in TIPS. Any experience/alternatives/opinions folks on this forum are willing to share will be most welcome and appreciated. Thanks in advance.

User avatar
grabiner
Advisory Board
Posts: 22171
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Thoughts on using an ETF for TIPS investing

Post by grabiner » Wed Jul 11, 2018 8:36 pm

Welcome to the forum!

There is no free lunch in the market. The higher the yield on your bonds, the more risk of some type you will take, so you have to decide whether taking that risk is worthwhile.

Note that I said, "in the market". Outside your IRA, you can buy I-Bonds, which are not traded in the market; unlike other bonds, they will not lose value if rates rise. If you buy an I-Bond with a 0% rate above inflation, you can cash it in at any time from 1-30 years (small penalty for less than 5 years), and get the original value plus inflation; you will pay federal but not state tax on the gains.

Inside an IRA, or if you are over the limit for I-Bond purchases ($10,000 per person per year), TIPS are a low-risk investment, but not risk-free. As with other bonds, they will lose value if their own rates rise. However, they are less risky, because increased inflation will not cause TIPS rates to rise, nor cause the real value of the bonds to fall.

So, if you are subject to inflation risk, TIPS do make sense, and a low-cost ETF is a reasonable way to hold one. Choose a fund duration which is no longer than your time horizon; for example, if you will be spending money in five years, you don't want ten-year bonds. (You can change to a shorter duration later.)

Link to list of TIPS ETFs on ETF.com Choose your duration, then look for the lowest-cost funds. I like Vanguard's VTIP for short-term (0.06% expenses), Schwab's SCHP for intermediate-term (0.05% expenses), and PIMCO's LTPZ is the only long-term choice (0.20% expenses).
Wiki David Grabiner

PFInterest
Posts: 1446
Joined: Sun Jan 08, 2017 12:25 pm

Re: Thoughts on using an ETF for TIPS investing

Post by PFInterest » Wed Jul 11, 2018 8:38 pm

PalmQueen wrote:
Wed Jul 11, 2018 6:46 pm
Greetings - Currently, the "fixed income position" in my portfolio consists of money market accounts. I'm tempted to leave it there now that interest rates are on the rise but also feel there are other options which would provide better returns which also have low risk. Hence, I'm looking at ETFs that invest in TIPS. Any experience/alternatives/opinions folks on this forum are willing to share will be most welcome and appreciated. Thanks in advance.
How long have you been in MM funds?

User avatar
FIREchief
Posts: 2205
Joined: Fri Aug 19, 2016 6:40 pm

Re: Thoughts on using an ETF for TIPS investing

Post by FIREchief » Wed Jul 11, 2018 9:21 pm

TIPS are so easy to just buy and hold individually. Why not just do that and save a small amount of expenses?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

averagedude
Posts: 151
Joined: Sun May 13, 2018 3:41 pm

Re: Thoughts on using an ETF for TIPS investing

Post by averagedude » Wed Jul 11, 2018 9:50 pm

I believe you should know the purpose of your fixed income investments. It isn't the same for all investors. If your purpose is inflation protection, tips should be one of your primary holdings.

PalmQueen
Posts: 3
Joined: Sun Jul 08, 2018 6:09 pm

Re: Thoughts on using an ETF for TIPS investing

Post by PalmQueen » Wed Jul 11, 2018 11:34 pm

Thank you for your insights.
I'll consolidate responses to your questions -
grabiner - Thank you for your welcome. You make good points about I-Bonds. They're more attractive since there's only a small penalty if you need to cash them out. Most of these funds are what I call sideline cash, so doubt that would be necessary. (Thanks for the tip on ETF.com. I was thinking of asking the group whether their information is reliable, so thanks for already answering.)
I have a follow-up question: The main reason ETFs appeal to me rather than just buying TIPS directly is that I had the impression those shares could be bought and sold without regard to the length of terms of the TIPS held in the fund, making the funds a bit more liquid. Was I confused about that?

PFInterest - I've kept a portion of total portfolio on MMs for years and years as a safe harbor. If everything else goes South, that will be there.
I'm thinking it would be good to put it to work someplace with a bit more return yet still low risk.

FIREchief - I was originally thinking of purchasing short term TIPS individually. When I looked into the ETFs, it seemed to me that since they hold a variety of time length TIPS, they may provide a bit more return with more liquidity.

averagedude - You nailed it. I'm looking for inflation protection.

This was my first post, so apologies if the combined response isn't the best way to do it. The system seemed to default to this format.
Thank you all!

stlutz
Posts: 4538
Joined: Fri Jan 02, 2009 1:08 am

Re: Thoughts on using an ETF for TIPS investing

Post by stlutz » Wed Jul 11, 2018 11:59 pm

PalmQueen: Since you are looking at switching from a money market fund to a TIPS fund, you should be aware that TIPS do fluctuate in value from year to year due to changes in real interest rates. Vanguard's TIPS fund was down 8.61% in 2013.

Now, that's not to scare you away--it's simply to make sure you are aware that the properties of a TIPS ETF (and individual TIPS bonds) are different from a money market fund.

Over time, TIPS are a low-risk investment and will provide a return somewhat higher than inflation. The route to get there is not perfectly smooth, however.

The money market fund offers a perfectly smooth ride, but generally gives you a return somewhat less than inflation, particularly after taxes are taken into account.

User avatar
Phineas J. Whoopee
Posts: 7183
Joined: Sun Dec 18, 2011 6:18 pm

Re: Thoughts on using an ETF for TIPS investing

Post by Phineas J. Whoopee » Thu Jul 12, 2018 5:00 pm

If I may, to help readers who aren't already familiar with bogleheads.org jargon, David is referring to Series I Savings Bonds.
PJW

User avatar
grabiner
Advisory Board
Posts: 22171
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Thoughts on using an ETF for TIPS investing

Post by grabiner » Thu Jul 12, 2018 7:48 pm

PalmQueen wrote:
Wed Jul 11, 2018 11:34 pm
I have a follow-up question: The main reason ETFs appeal to me rather than just buying TIPS directly is that I had the impression those shares could be bought and sold without regard to the length of terms of the TIPS held in the fund, making the funds a bit more liquid. Was I confused about that?
You can also buy and sell individual TIPS in your brokerage account.

The advantage of the ETF is convenience. If you have ten individual bonds, you have to keep track of all ten, and unless you want your portfolio duration to shorten, you have to sell shorter-term bonds to buy longer-term bonds. The ETF will keep its duration as it sells shorter-term bonds to buy longer-term bonds on its own; you can change duration when you want to change, by selling an intermediate-term ETF to buy a short-term ETF. (The handling of taxes is also simpler with ETFs, although this is not relevant if the TIPS ETF is held in an IRA.)

Normally, bond funds have the additional advantage over individual bonds that it is easier to get diversification with a fund. However, for TIPS funds, there is no need for diversification, as all the bonds are guaranteed by the government. (In contrast, if you wanted to hold corporate bonds, you would prefer to have a fund holding 100 different bonds so that you would only have a 1% loss if one defaulted.)
Wiki David Grabiner

PalmQueen
Posts: 3
Joined: Sun Jul 08, 2018 6:09 pm

Re: Thoughts on using an ETF for TIPS investing

Post by PalmQueen » Thu Jul 12, 2018 9:03 pm

grabiner wrote:
Thu Jul 12, 2018 7:48 pm
PalmQueen wrote:
Wed Jul 11, 2018 11:34 pm
I have a follow-up question: The main reason ETFs appeal to me rather than just buying TIPS directly is that I had the impression those shares could be bought and sold without regard to the length of terms of the TIPS held in the fund, making the funds a bit more liquid. Was I confused about that?
You can also buy and sell individual TIPS in your brokerage account.

The advantage of the ETF is convenience. If you have ten individual bonds, you have to keep track of all ten, and unless you want your portfolio duration to shorten, you have to sell shorter-term bonds to buy longer-term bonds. The ETF will keep its duration as it sells shorter-term bonds to buy longer-term bonds on its own; you can change duration when you want to change, by selling an intermediate-term ETF to buy a short-term ETF. (The handling of taxes is also simpler with ETFs, although this is not relevant if the TIPS ETF is held in an IRA.)

Normally, bond funds have the additional advantage over individual bonds that it is easier to get diversification with a fund. However, for TIPS funds, there is no need for diversification, as all the bonds are guaranteed by the government. (In contrast, if you wanted to hold corporate bonds, you would prefer to have a fund holding 100 different bonds so that you would only have a 1% loss if one defaulted.)
Thank you! I've spent (way too many) hours researching this and you're the first to explain it clearly and concisely in a way that makes sense to me. I appreciate your help.

User avatar
galeno
Posts: 1187
Joined: Fri Dec 21, 2007 12:06 pm

Re: Thoughts on using an ETF for TIPS investing

Post by galeno » Fri Jul 13, 2018 7:33 pm

15% of our 40/60 portfolio is in ONE TIPS ETF. We like it just fine.

We use the TIPS ETF to protect 25% of our fixed income allocation from unexpected inflation.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.4%. Port Yield = 2.0%. Term = 35 yr. FI Duration = 6.2 yr. Portfolio survival probability = 100%.

Post Reply