TIPS Tip

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Doc
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Post by Doc » Sun Mar 08, 2009 12:05 pm

Beagler wrote: Indeed, imagine the retiree who makes a monthly VIPSX redemption to make ends meet: s/he has experienced firsthand a 24% share price fluctuation over the past 52 weeks. Nothing abstract about 24%.

Beagler,

You are equating two different concepts that are not the same.

If someone needs to make monthly withdrawals from their bond portfolio that portfolio should not be a fund with a duration of 8 to 10 years. A prudent investor would match their bond portfolio to their cash flow needs. One way to do this is with a bond ladder where the maturing bonds are not reinvested. Another way is to use several bond funds to the same effect. A (Treasury) MM fund, an ultra short fund, a short term fund, an intermediate fund and maybe a long term fund. In the long run you have to sell long bonds and buy short ones but you don't have to do it every month and you wouldn't if the NAV was way down.

Your problem is that the portfolios duration is not matched to your cash flow needs. You need to have a better match but that match can be made without regard as to whether the portfolio is made up of funds or individual notes.
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Post by Beagler » Sun Mar 08, 2009 1:52 pm

Good points, doc. While an assembly of bond funds as you've outlined would address the duration aspect, unfortunately VG's TIPS fund comes in only one flavor.

For those folks who buy individual TIPS regularly (up to quarterly, at auction) they've got a ladder that will mature regularly in retirement. Like all ladders, the investor can choose to spend or reinvest part or all of the proceeds.

Larry's bond book has a nice section on laddering which has always made a lot of sense to me.
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Post by Doc » Sun Mar 08, 2009 2:15 pm

Beagler wrote:While an assembly of bond funds as you've outlined would address the duration aspect, unfortunately VG's TIPS fund comes in only one flavor.

You could use a Treasury MM fund and a Short Treasury fund on the short end and the TIPS fund at the longer end as a compromise. I don't tend to worry about unexpected inflation on the short end of the curve anyway.

I feel really weird supporting the mutual fund side of this discussion when I myself use a ladder. :)
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Post by sewall » Sun Mar 08, 2009 3:46 pm

Doc wrote:
Beagler wrote:While an assembly of bond funds as you've outlined would address the duration aspect, unfortunately VG's TIPS fund comes in only one flavor.

You could use a Treasury MM fund and a Short Treasury fund on the short end and the TIPS fund at the longer end as a compromise. I don't tend to worry about unexpected inflation on the short end of the curve anyway.

I feel really weird supporting the mutual fund side of this discussion when I myself use a ladder. :)


That's a sign of intellectual honesty. I should start arguing for a ladder I guess. :lol:
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Post by Beagler » Sun Mar 08, 2009 5:33 pm

Wow, holding multiple non-TIPS funds plus VIPSX -- all in the hopes of accomplishing what a simple TIPS ladder will accomplish. :D I think I'll stick with a ladder (as you do, doc).
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Post by Doc » Sun Mar 08, 2009 6:18 pm

Beagler wrote:Wow, holding multiple non-TIPS funds plus VIPSX -- all in the hopes of accomplishing what a simple TIPS ladder will accomplish.

Don't get too excited. I already have the Treasury MM and Short term Treasury to hold funds for cash on hand and short term needs so I would only have to add VIPSX. :wink:

And I wouldn't have to worry about amortizable bond premium and original interest discount and accrued interest and calculating the inflation adjusted price every week because VBS doesn't understand the real world. :P
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Post by tetractys » Sun Mar 08, 2009 6:43 pm

Beagler wrote:
tetractys wrote:
Beagler wrote:A 24% NAV fluctuation in the past 52 weeks is plenty of evidence that your returns can vary.

Of course your returns will vary if you have to sell, and that's what people are saying. You'd have these fluctuations if you HAD to sell parts of your bond ladder as well. But if you don't have to sell, fund or bond ladder, it's like holding to maturity, you get your income, and that's what people are saying as well. Why quibble over words?


I guess my point boils down to the retiree who's relying on their TIPS for income, and doesn't have the luxury of waiting until the TIPS fund NAV comes back up to par, so to speak. For those who will need income on a regular basis, a fund's fluctuating NAV (esp. like the 24% we've seen) could be both unnerving and financially unwelcome.

The retiree still gets the income regardless of NAV. -- Tet
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Post by Beagler » Sun Mar 08, 2009 7:31 pm

tetractys wrote:The retiree still gets the income regardless of NAV. -- Tet


As you know, with TIPS the Big Payoff is with the inflation-adjusted return of principal. When liquidating shares you're at the mercy of the NAV the day of your redemption, right?

On its side, VIPSX has convenience and relatively low ER. The fund's duration is at the discretion of the fund managers. There is no guarantee of return of principal. VIPSX has demonstrated significant NAV variation.

A ladder has zero expenses, and guarantees return of principal + accrued interest + inflation adjustment. Over time, a ladder may return less, more or the same as VIPSX.

As it happens, I was rereading some of Thau's bond book today. In the section on asset allocation she recommends Treas. Notes of 2-5 years duration. She recommends a ladder, not a fund. Imagine that. :wink:
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Post by tetractys » Sun Mar 08, 2009 8:38 pm

Beagler wrote:
tetractys wrote:The retiree still gets the income regardless of NAV. -- Tet


As you know, with TIPS the Big Payoff is with the inflation-adjusted return of principal. When liquidating shares you're at the mercy of the NAV the day of your redemption, right?

On its side, VIPSX has convenience and relatively low ER. The fund's duration is at the discretion of the fund managers. There is no guarantee of return of principal. VIPSX has demonstrated significant NAV variation.

A ladder has zero expenses, and guarantees return of principal + accrued interest + inflation adjustment. Over time, a ladder may return less, more or the same as VIPSX.

As it happens, I was rereading some of Thau's bond book today. In the section on asset allocation she recommends Treas. Notes of 2-5 years duration. She recommends a ladder, not a fund. Imagine that. :wink:

Your skirting the issue Beagler, hiding from what's been established, and throwing out straw. -- Tet
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Post by Blues » Sun Mar 08, 2009 8:44 pm

tetractys wrote:Your skirting the issue Beagler; or in your own terms, kicking your dog. -- Tet


And I thought it was just the flogging of a dead horse! :lol:

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Post by Beagler » Sun Mar 08, 2009 9:54 pm

tetractys wrote:
Beagler wrote:
tetractys wrote:The retiree still gets the income regardless of NAV. -- Tet


As you know, with TIPS the Big Payoff is with the inflation-adjusted return of principal. When liquidating shares you're at the mercy of the NAV the day of your redemption, right?

On its side, VIPSX has convenience and relatively low ER. The fund's duration is at the discretion of the fund managers. There is no guarantee of return of principal. VIPSX has demonstrated significant NAV variation.

A ladder has zero expenses, and guarantees return of principal + accrued interest + inflation adjustment. Over time, a ladder may return less, more or the same as VIPSX.

As it happens, I was rereading some of Thau's bond book today. In the section on asset allocation she recommends Treas. Notes of 2-5 years duration. She recommends a ladder, not a fund. Imagine that. :wink:

Your skirting the issue Beagler, hiding from what's been established, and throwing out straw; [personal attack removed]. -- Tet


Not hardly. When you can prove to me that VIPSX provides a written guarantee of return of principal + interest + inflation adjustment, then I'll be on board. Until then, no one can convince me that holding the fund will provide the same guarantee as holding individual TIPS.

That's really what it boils down to.

As Bodie has written, a TIPS fund can provide most but not all of the benefits of holding individual TIPS. Perhaps you know more about the subject than he does?

A bond fund does not a bond ladder make. :wink:

Edit: Your comment about kicking a dog is way out of line. I can assure you that my family and I have done more for animal protection, both in personal time and treasure, than you can possibly imagine.
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Post by tarnation » Sun Mar 08, 2009 10:51 pm

tfb wrote:Feel free to change the numbers in this example. You will see no matter what your partner does, as long as it's done at the NAV and the portfolio allocation remains the same, your cash flow is always the same. Actions by a partner in "our bond fund" does not affect you.


Thanks for the lengthy example (and you even picked numbers so the math works out cleanly). I agree with your results exactly, but it is POSSIBLE to change the numbers and get a different result.

Suppose you and 99 partners go out and buy two zero coupon bonds: a short-term bond S and a long-term bond L. The price for S is 90; price for L is 60. You buy 10 bonds in S and 10 bonds in L. Total cash outlay is 10 * 1000 * 90% + 10 * 1000 * 60% = $15k, which you split 1/99 with your partners. You call this "our bond fund" and issue 1000 shares, 10 shares to you, 990 shares to your partners. The NAV is $15. If the whole of you don't do any buy or sell, you expect to receive $100 when bond S matures and another $100 when bond L matures.

A year later, interest rates are higher. The price for S is now 85 (down from 90); 45 for L (down from 60). Value of "our bond fund" is 10 * 1000 * 85% + 10 * 1000 * 45% = $13k. NAV is $13 (down from $15). Your partner is impatient. He decides to sell 100% of his holdings, which is 990 shares. That's 99% of "our bond fund." So the fund sells 10 bonds from S and 10 bonds from L. Your partner receives $13 * 990 = $12,870 in cash for redeeming 990 shares. You still have your 10 shares. Your partner only has 0 shares now.

Your share of the proceeds are $13*10 = $130.

You wonder if your partner's premature redemption at year 1 when prices were low affected you. Had he stuck it together with you, you would receive $100 when bond S matured and $100 when bond L matured. Hmmm ... isn't that what you received anyway? No.
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Post by tetractys » Sun Mar 08, 2009 11:21 pm

Sorry Beagler.
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Post by tfb » Sun Mar 08, 2009 11:49 pm

tarnation wrote:Your partner is impatient. He decides to sell 100% of his holdings, which is 990 shares. That's 99% of "our bond fund." So the fund sells 10 bonds from S and 10 bonds from L. Your partner receives $13 * 990 = $12,870 in cash for redeeming 990 shares. You still have your 10 shares. Your partner only has 0 shares now.

Your share of the proceeds are $13*10 = $130.

I agree in the case of a total liquidation you will be affected by other shareholders. If that happens, you reinvest your $130 into a different fund, which is also down.
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Post by sewall » Mon Mar 09, 2009 7:55 am

Deleted--not relevant to conversation.
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Post by tarnation » Mon Mar 09, 2009 10:19 am

tfb wrote:
tarnation wrote:Your partner is impatient. He decides to sell 100% of his holdings, which is 990 shares. That's 99% of "our bond fund." So the fund sells 10 bonds from S and 10 bonds from L. Your partner receives $13 * 990 = $12,870 in cash for redeeming 990 shares. You still have your 10 shares. Your partner only has 0 shares now.

Your share of the proceeds are $13*10 = $130.

I agree in the case of a total liquidation you will be affected by other shareholders. If that happens, you reinvest your $130 into a different fund, which is also down.

Maybe, but the results of this improbable event does establish that the statement, "A TIPS ladder isn't any different than a TIPS fund.", is not correct.
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Post by Indexer88 » Mon Mar 09, 2009 10:20 am

This has been a good discussion for me about TIPS fund vs. ladder.

One usual comment is that "a TIPS fund is more convenient." However, the volatility in NAV price makes both contributing and withdrawing incovenient. 24% volatility. This is not acceptable, let alone inconvenient.

Another usual comment is that "a TIPS fund protects the individual from making managerial mistakes." Yet, because the TIPS fund itself is volatile, the individual investor can make a "management" mistake in buying the fund at the wrong time. An individual may not buy the right TIPS bond, but you can only lose 24% by buying the fund. You'll never lose 24% in any individual TIPS bond you buy. And there is also the regular managerial risk of the fund manager. So, a TIPS fund actually poses two levels of managerial risk.

Why are TIPS funds so volatile? Any TIPS fund's NAV seems captive to the marketplace. Flight to safety, market forces, and capital needs can force selling on the TIPS market, bringing the whole TIPS secondary market down. In a ladder, you need only let your next bonds come to maturity. The secondary market will cause you no loss in the withdrawal process.

It seems to me a TIPS fund only offers the illusion of convenience. Because of the volatility of a fund, you will start planning contributions and withdrawals based upon swings in prices, thus doing as much work, with more more worry, than just having a ladder. Am I missing something?

24%!!!!! That's the safe side of our retirement?

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Post by sewall » Mon Mar 09, 2009 10:40 am

Indexer88 wrote:Am I missing something?


I would answer this with a qualified "yes". However, I'm not going to repeat the same things I've already posted. If you want to go over it again you can just look back on the posts in this thread. Or, if you want to see it again in a slightly different context you can look here.

I'll just say, if one wants to discuss how funds and ladders are different or similar then one has to be very precise about what one is talking about. One has to compare apples to apples if one wants to argue based on NAV swings. Bond funds have NAV swings. So do ladders. That doesn't make them the same in all respects. But those are true statements.

However, and here is the qualification of that "yes", in the end, even a discussion such as this will not reveal which is "better" for a particular investor apart from particulars about that investor, what his/her concerns are about predictability, various types of risk, and so on. Only one of the following can be true for you: (A) a bond fund is not significantly different than a bond ladder or (B) it is. No matter how you answer that question you can still justify a ladder over a fund (or vice versa) for yourself. Whatever you believe to be the best thing for you, your peace of mind, and so on, that's what you should do. But no matter your choice it won't change facts about NAV swings and the extent to which they're relevant for a fund holder or a ladder holder.
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Post by Doc » Mon Mar 09, 2009 12:25 pm

sewall wrote: I'll just say, if one wants to discuss how funds and ladders are different or similar then one has to be very precise about what one is talking about. One has to compare apples to apples if one wants to argue based on NAV swings. Bond funds have NAV swings. So do ladders. That doesn't make them the same in all respects. But those are true statements.

If the ladder and the fund have the same duration there will be essentially no difference in their performance period no matter what the going interest rate is at any point in time. That's what duration is all about. The problem arises when you have a liquidating ladder. In that case you have apples to apples the first day (same duration) but apples to pears after a few years (the duration of the ladder has changed but the fund manager kept his duration constant) and apples to horse meat when you only have a few bonds left in the ladder.

As Sewall says you have to be precise in the definitions.
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Post by Dan Kohn » Mon Mar 09, 2009 1:41 pm

Indexer88 wrote:Another usual comment is that "a TIPS fund protects the individual from making managerial mistakes." Yet, because the TIPS fund itself is volatile, the individual investor can make a "management" mistake in buying the fund at the wrong time. An individual may not buy the right TIPS bond, but you can only lose 24% by buying the fund. You'll never lose 24% in any individual TIPS bond you buy. And there is also the regular managerial risk of the fund manager. So, a TIPS fund actually poses two levels of managerial risk.

Why are TIPS funds so volatile? Any TIPS fund's NAV seems captive to the marketplace. Flight to safety, market forces, and capital needs can force selling on the TIPS market, bringing the whole TIPS secondary market down. In a ladder, you need only let your next bonds come to maturity. The secondary market will cause you no loss in the withdrawal process.

This is deeply incorrect. If you set up a bond ladder in early 2008, and decided you needed access to your full principal in the end of the year, you would have been out the same 24% as if you sold the bond fund. If you are comparing a rolling bond ladder to a bond fund, and they have the same duration, then they will behave the same.

For more info, see:
viewtopic.php?p=422451#422451
(My apologies for the similar thread.)

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Post by Indexer88 » Mon Mar 09, 2009 3:55 pm

Dan, if you set up a bond ladder covering 2 to 20 years, you probably would not want access to the full principle in most cases. I'm not saying you would want to cash in the whole fund.

However, you might reasonably want to withdraw 10-20% within a year or two. A retired person might be counting on some cash in a couple years after stopping work. If you bought a single bond with two years left to maturity, as part of your ladder, you could get your full principal back on that bond, plus possible interest. If all your money was in a fund, you would face a 24% penalty. (This seems to be the duration issue.)

The confusion is when comparing the total NAV of all bonds held with the short term bonds one wants to convert to cash. The problem with a fund is the short-term redemption squeeze.

In a TIPS fund, early withdrawals bear the market markdown of the entire fund's holdings.

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Post by Doc » Mon Mar 09, 2009 4:05 pm

Indexer88 wrote:Dan, if you set up a bond ladder covering 2 to 20 years, you probably would not want access to the full principle in most cases.

...

The confusion is when comparing the total NAV of all bonds held with the short term bonds one wants to convert to cash. The problem with a fund is the short-term redemption squeeze.

In a TIPS fund, early withdrawals bear the market markdown of the entire fund's holdings.

The situation you are addressing has little to do with ladders vs. funds. It has to do with having the duration of your FI investments matching your cash flow needs. If you have a short term need you shouldn't have that money in a fund with an 8 year duration. It should be in a short term investment - either a short term fund or an individual note. In order to meet all your cash flow needs you might need several different investment vehicles - either individual bonds or funds or even a combination of the two - each with different durations to match your needs.
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Nope

Post by Dan Kohn » Mon Mar 09, 2009 10:46 pm

Indexer88 wrote:However, you might reasonably want to withdraw 10-20% within a year or two. A retired person might be counting on some cash in a couple years after stopping work. If you bought a single bond with two years left to maturity, as part of your ladder, you could get your full principal back on that bond, plus possible interest. If all your money was in a fund, you would face a 24% penalty. (This seems to be the duration issue.)

This is wrong. You have ten bonds in a ladder, one year apart. After the end of year 1, you decide to spend the principal of the maturing bond, rather than reinvest it. What you're missing is that in not rolling over that bond, you are significantly reducing the future return of your ladder. In fact, if a bond fund would be facing a 24% penalty, than yields have skyrocketed. So, not reinvesting that first bond has a huge opportunity cost to your ladder, because you're missing the chance to buy a new 10 year bond at those super-high yields.

That's the lesson of tfb's mental exercise to calculate a NAV for your ladder. You'll find that in not rolling over a bond, the NAV of your ladder faces the same reduction as selling the same dollars worth of a bond fund.

Indexer88 wrote:The confusion is when comparing the total NAV of all bonds held with the short term bonds one wants to convert to cash. The problem with a fund is the short-term redemption squeeze. In a TIPS fund, early withdrawals bear the market markdown of the entire fund's holdings.

No, you're getting confused by thinking that there's something special about holding a bond to maturity. The prices of all of the bonds in your bond ladder and all of the bonds in the bond fund are reacting identically to interest rate changes. Bond fund managers hold bonds to maturity all the time. As long as we're talking about a rolling bond ladder that has the same duration as the bond fund, they will react the same, however you make your withdrawals.

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Post by grayfox » Tue Mar 10, 2009 3:50 am

Here is a difference between a TIPS ladder and a Vanguard Inflation-Protected Securities fund VIPSX.

Up to 20% of the fund’s assets may be invested in holdings that are not inflation-indexed. The fund will make such investments primarily when inflation-indexed bonds are less attractive. The fund’s non-inflation-indexed holdings may include the following:

* Corporate debt obligations.
* U.S. government and agency bonds.
* Cash investments.
* Futures, options, and other derivatives.
* Restricted or illiquid securities.
* Mortgage dollar rolls

The fund is like sausage. You really don't know what's inside.
On the other hand, your TIPS ladder is like 100% Certified Grade AAA Beef.
So you have a choice between a hot dog or steak, and the steak is cheaper. I guess some people choose the hot dog because it is more convenient.

Here is another thing. Vanguard lists the VIPSX holdings, but they only update it about once per quarter. The last time it was updated was 12/31/2008. Why can't they show the holdings every day? Don't they have computers that can calculate that sort of thing?

How do you know that the VIPSX managers aren't making a bunch of bets with derivatives and then at the end of the quarter adding a bunch of window dressing?

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VIPSX

Post by Dan Kohn » Tue Mar 10, 2009 6:31 am

VIPSX is also actively managed, not an index fund. If you want 100% pure, indexed TIPS fund, consider the ETF IPE (SPDR Barclays Capital TIPS). Expense ratio is 0.19, but there's no doubt what you're getting.

Note that Vanguard runs the best bond shop in the business (better than PIMCO even, I would argue), and that they use their actively managed portfolio to ride the yield curve one year either way to eke out a few extra tens of basis points either way. They've been great at it in the past. But for purity, go with IPE.

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Post by sewall » Tue Mar 10, 2009 7:52 am

We can certainly argue the differences and merits of a ladder vs fund and we have more to discuss when we talk about a specific fund like VIPSX.

But the bulk of the discussion and disagreement so far has been over a misunderstanding about NAV effects in a ladder and/or over lack of clarity in defining the terms of the debate.

I hope by now the facts that ladders have NAV fluctuations and that a rolling ladder can be identical to a fund is clear to all. The implication of these facts is that one cannot argue against a fund on NAV grounds alone. It is not a valid argument. Yet it is made all the time.
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Post by Indexer88 » Tue Mar 10, 2009 8:38 am

Thanks for the replies. As I said, I am envisioning not a rolling ladder in which one continually reinvests principle, but a ladder in which bonds are converted to cash as they come to maturity. When in the withdrawal stage, it's nice to know that you can get your full principal back on the short term bonds, without having the overall fund NAV fluctuations affect those early withdrawals.

Also, my imperfect sense is that VIPSX saw a sharp downward NAV without a corresponding increase in yield because of deflation fears.

VIPXS has an average 8 year duration. Does that mean an indivudal TIPS bond of 8 year duration would also have seen the 24% loss that VIPSX did? Does the 8 year duration guarantee a return to the NAV before downturns in 8 years?

Thanks to grayfox for the detailed account of what is in VIPSX. I wonder what role that 20% in non-TIPS did to the NAV this past fall. Thanks to Dan for information about ETF IPE (SPDR Barclays Capital TIPS).

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Post by Beagler » Tue Mar 10, 2009 8:41 am

grayfox wrote:Here is a difference between a TIPS ladder and a Vanguard Inflation-Protected Securities fund VIPSX.

Up to 20% of the fund’s assets may be invested in holdings that are not inflation-indexed. The fund will make such investments primarily when inflation-indexed bonds are less attractive. The fund’s non-inflation-indexed holdings may include the following:

* Corporate debt obligations.
* U.S. government and agency bonds.
* Cash investments.
* Futures, options, and other derivatives.
* Restricted or illiquid securities.
* Mortgage dollar rolls

The fund is like sausage. You really don't know what's inside.
On the other hand, your TIPS ladder is like 100% Certified Grade AAA Beef.
So you have a choice between a hot dog or steak, and the steak is cheaper. I guess some people choose the hot dog because it is more convenient.

Here is another thing. Vanguard lists the VIPSX holdings, but they only update it about once per quarter. The last time it was updated was 12/31/2008. Why can't they show the holdings every day? Don't they have computers that can calculate that sort of thing?

How do you know that the VIPSX managers aren't making a bunch of bets with derivatives and then at the end of the quarter adding a bunch of window dressing?


Thanks for highlighting this. VIPSX is actively managed and may not be "all TIPS, all the time." It's possible for the managers to add value, but as Larry points out in his bond book, it's not easy.
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Post by Dan Kohn » Tue Mar 10, 2009 8:58 am

Indexer88 wrote:Thanks for the replies. As I said, I am envisioning not a rolling ladder in which one continually reinvests principle, but a ladder in which bonds are converted to cash as they come to maturity. When in the withdrawal stage, it's nice to know that you can get your full principal back on the short term bonds, without having the overall fund NAV fluctuations affect those early withdrawals.

Thus we see the importance of definitions. If you want to take the same amount of money out every year for the next 10 years or so, then you have a series of (real) future liabilities. And a non-rolling TIPS ladder is the ideal mechanism to deal with date-certain future liabilities.

If instead you want to withdrawal a set amount (say 4% SWR) of your total portfolio (of which TIPS are just a portion) over several decades, while also rebalancing with nominal bonds and equity, than there are enormous advantages to using a fund, due to the convenience and ease of buying, selling, and reinvesting.

Indexer88 wrote:Also, my imperfect sense is that VIPSX saw a sharp downward NAV without a corresponding increase in yield because of deflation fears.

Deflationary expectations mean that the real yield increases even as the nominal yield stays flat. There's no more iron rule than the inverse relationship of bond yields and price.

Indexer88 wrote:VIPXS has an average 8 year duration. Does that mean an indivudal TIPS bond of 8 year duration would also have seen the 24% loss that VIPSX did? Does the 8 year duration guarantee a return to the NAV before downturns in 8 years?

Any set of bonds (including a single one) with the same duration would have reacted the same as VIPSX. Note that VIPSX's duration is actually 6.0 years.

Indexer88 wrote:Thanks to grayfox for the detailed account of what is in VIPSX. I wonder what role that 20% in non-TIPS did to the NAV this past fall. Thanks to Dan for information about ETF IPE (SPDR Barclays Capital TIPS).

The fund can hold up to 20% in non-TIPS. Currently, it holds 1.2% non-TIPS. You can see the impact by comparing the performance against the index. 20 basis points of difference is due to the expense ratio. In 2008, VIPSX underperformed the index by an additional 61 basis points, either by not being fully invested in TIPS or by being at a different point on the yield curve than the index.

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Post by Gregory » Tue Mar 10, 2009 9:03 am

sewall wrote:We can certainly argue the differences and merits of a ladder vs fund and we have more to discuss when we talk about a specific fund like VIPSX.

But the bulk of the discussion and disagreement so far has been over a misunderstanding about NAV effects in a ladder and/or over lack of clarity in defining the terms of the debate.

I hope by now the facts that ladders have NAV fluctuations and that a rolling ladder can be identical to a fund is clear to all. The implication of these facts is that one cannot argue against a fund on NAV grounds alone. It is not a valid argument. Yet it is made all the time.


* NAV change has no practical significance for a bond ladder -- those bonds are held to maturity. (Assuming you're going to spend the proceeds at maturity.) At least that's my general impression.

* As has been pointed out, if rates change (increase) when you liquidate bond fund shares, those NAV changes can be meaningful.

* VG runs respected bond funds. If anyone's looking out for the investor, it's VG. No reason to think they won't do their best with VIPSX.

* I love the VIPSX = sausage analogy.

* Look at VIPSX's holdings: there's a few rungs missing! Not a good comparison to a rolling ladder where someone has purchased bonds yearly (or more often) and has a rung maturing yearly (or more often). Also, how can a fund that can hold up to 20% of non-TIPS investments be considered equivalent to a rolling pure bond fund?

* Interesting quote from a respsected poster:
ddb wrote:There is no time period over which an investor in any bond fund is assured that s/he will get back at least his/her principal.

- DDB
Last edited by Gregory on Tue Mar 10, 2009 9:25 am, edited 2 times in total.
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Response

Post by Dan Kohn » Tue Mar 10, 2009 9:11 am

Gregory wrote:* NAV change has no practical significance for a bond ladder -- those bonds are held to maturity.

* As has been pointed out, if rates change (increase) when you liquidate bond fund shares, those NAV changes can be meaningful.

* VG runs respected bond funds. If anyone's looking out for the investor, it's VG. No reason to think they won't do their best with VIPSX.

* I love the VIPSX = sausage analogy.

* Interesting quote from a respsected poster:
ddb wrote:There is no time period over which an investor in any bond fund is assured that s/he will get back at least his/her principal.

No, no, no. Please read that full thread, which explains that (although this is only useful from a theoretical standpoint) you can always get back your principal from a bond fund by selling the fund and buying a zero coupon bond, where on average the duration of that bond will equal the duration of the fund. You'll see ddb acknowledges he was wrong on that point about getting back principal, and concludes with this:

ddb wrote:
Dan Kohn wrote:The key thought is that although bond funds do have volatility, they are exactly as volatile as a rolling bond ladder with the same duration.

Yes! Perfect way to compress the main points of this thread into a single sentence.

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Re: Response

Post by Gregory » Tue Mar 10, 2009 9:21 am

Dan Kohn wrote:....you can always get back your principal from a bond fund by selling the fund and buying a zero coupon bond


How is going through all that superior to simply holding the bond to maturity?

Edit: Dan, about the ddb quote, I guess the word I keyed in on "assured."
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Re: Response

Post by sewall » Tue Mar 10, 2009 9:38 am

Gregory wrote:
Dan Kohn wrote:....you can always get back your principal from a bond fund by selling the fund and buying a zero coupon bond


How is going through all that superior to simply holding the bond to maturity?


Not the point. Not even close. Read the threads (this one and the others referenced). This is not a debate about absolute superiority of one way or another. It is about understanding how these things work, what is true about them, and what is mythology.
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Re: Response

Post by Dan Kohn » Tue Mar 10, 2009 9:48 am

Gregory wrote:Edit: Dan, about the ddb quote, I guess the word I keyed in on "assured."

Yes, and at any moment after buying a bond fund, you can always be assured of getting your principal back. Doing so requires selling the fund and buying a zero-coupon bond with the face value of your principal. Such a bond will always be available, because if the fund's NAV is down, yields will have gone up a commensurate amount.

Now, here's the wacky thing. At any moment after setting up a bond ladder, you can always be assured of getting your principal back. There are two ways of doing it. One, let the whole ladder expire, in which case you have to wait as long as the longest bond. Two, sell all of the bonds in the ladder, and buy a single zero-coupon bond with a face value equal to the original principal. On average, the second method will get you your principal back in half the time as the first method.

As sewall said, this is not about superiority. Please think carefully about this, and you can see when a non-rolling bond ladder is best for fulfilling date-certain future liabilities, and when you want a bond fund or a rolling bond ladder. But, contrary to many of the earlier posts on this thread, there is no safety or volatility difference between a bond fund and a rolling bond ladder (with the same duration, of course).

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Post by Gregory » Tue Mar 10, 2009 10:03 am

Thanks for the explanation, Dan. Interesting way to look at things.
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Post by Indexer88 » Tue Mar 10, 2009 10:04 am

Dan, thanks for the correct duration of VIPSX at 6 years. My mistake.

Thanks for the reminder that the 20% is "up to" or a potential deviation from a 100% holding. That 20% is still worrisome for the long-term and adds risk to the part of my portfolio that is supposed to be balancing equity risk.

Yes, if one is planning to withdraw 4% per year, than a fund might make more sense. Or a non-rolling ladder could as well. Have maturing bonds at 2-4 year intervals, sell and use short-term CDs to cover the interim. Each four years you have a bond maturing with a known value. No worries about NAV. (Yes, NAV will vary on the ladder, but there are known value points throughout the future.)

Instead of holding only VIPSX, one should probably have something for the short term. It seems holding a second TIPS fund or a nominal treasury fund would balance withdrawal needs better. I will have to check if the NAV volativity is less with those. I know the short term treasury funds have done great b/c of a flight to safety. Not sure at all about short term TIPS funds or if there are any.

Thanks again to all. The posts have been helpful and I have learned a lot. And I thought bonds would be easier than equities!

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Re: Response

Post by Doc » Tue Mar 10, 2009 10:11 am

Dan Kohn wrote: Note that VIPSX's duration is actually 6.0 years.

I'm not sure what the Vanguard quoted duration actually means. From the footnotes on the linked page we have:

* This figure is an estimated yield-to-maturity (YTM) for the fund. It is calculated by adding the trailing 12-month inflation adjustment to the "real" (i.e., before inflation) YTM of the fund. Adding the 12-month inflation adjustment allows the fund's yield to be more directly comparable to those of other bond funds. Investors should recognize that the actual YTM will depend upon the level of inflation experienced going forward.

and

† This duration estimates the percentage change in the price of the fund for a given change in nominal interest rates on conventional Treasury securities. Actual inflation-protected securities (TIPS) price movements could be significantly different than implied by this estimate. The relationship of TIPS and conventional bonds varies and is difficult to predict with accuracy. Learn more about comparing TIPS and Treasuries.

Vanguard is modifying the standard calculation for YTM and duration for it TIPS funds in order to get these metrics to look more like nominal bonds. They do this by adding an inflation estimate into the calculation. (Since YTM is part of the duration calculation I assume that both are affected but it is not clear from the footnote.) Although arguably this non-standard calculation makes VIPSX more comparable to other nominal bond funds it makes it impossible to make comparisons to other TIPS funds or TIPS ladders which are using the standard calculations. I think Vg is doing us a disservice in their attempt here.
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Post by sewall » Tue Mar 10, 2009 10:13 am

Indexer88 wrote:Thanks again to all. The posts have been helpful and I have learned a lot. And I thought bonds would be easier than equities!


I, too, am grateful for all the fantastic and thoughtful input on these questions.

I have always found bonds to be vastly harder than equities. I think it is due fundamentally to their constraints. They're contracts with fixed characteristics (face value, maturity date, coupon, and so on). That makes reasoning about them harder because it has to conform to what is known about the instrument (or bundles thereof).

Equities, on the other hand, are much purer objects in a sense. They're just units of ownership. Beyond that, they're at the mercy of the market. Nothing is pinned down. Nothing is guaranteed. That makes thinking about them easier. The conceptual model is simpler and relatively more free than that of bonds.
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SWR

Post by Dan Kohn » Tue Mar 10, 2009 10:44 am

Indexer88 wrote:Yes, if one is planning to withdraw 4% per year, than a fund might make more sense. Or a non-rolling ladder could as well.

I think looking at your withdrawal rate is one interesting way to compare bond ladders and funds. If you withdrawal 10% of your original principal per year, then your money will only last 10 years. So, the risk of volatility in a bond fund (and in a rolling bond ladder) is way too high, given that a big drop in NAV in year 1 could really hurt your principal. This is another way of saying that a bear market is really tough at the beginning of your retirement, and challenges anything more than a 4% safe withdrawal rate. So, a non-rolling bond ladder is definitely the smart bet, of just buying bonds (zero-coupon, even), with maturities of 1 through 10 years.

But if you are withdrawing smaller amounts (like a 4% SWR), and want to continue doing so for 20 years or more, either a bond fund or a rolling bond ladder would work. But there is no difference in volatility between the two.

Indexer88 wrote:Each four years you have a bond maturing with a known value. No worries about NAV. (Yes, NAV will vary on the ladder, but there are known value points throughout the future.)

If you do not rollover a bond that is greater than your planned annual withdrawal, you have just suffered a NAV drop exactly equivalent to selling a fund when the NAV is down.

That's why the key distinction is between a rolling and a non-rolling ladder, not between a ladder and a fund. Your concept of known-value points are an illusion. Calculate the NAV of your ladder, and you will find it is identical to a fund.

Indexer88 wrote:Instead of holding only VIPSX, one should probably have something for the short term. It seems holding a second TIPS fund or a nominal treasury fund would balance withdrawal needs better. I will have to check if the NAV volativity is less with those. I know the short term treasury funds have done great b/c of a flight to safety. Not sure at all about short term TIPS funds or if there are any.

The standard Boglehead advice is to go 50/50 Total Bond and TIPS fund. The first protects you against deflation, and the latter protects you against inflation. Replacing Total Bond with the IT Treasuries fund is fine if you're particularly risk-averse.

If you want to shorten the duration of your TIPS fund (or rolling ladder), you can do simply by holding cash in a money market. The money market adjusts nearly instantly to inflation, and the 68 day maturity (or Prime Money Market) is averaged against the maturity of the bonds in your fund or ladder.

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Re: SWR

Post by sewall » Tue Mar 10, 2009 10:53 am

Dan Kohn wrote:If you want to shorten the duration of your TIPS fund (or rolling ladder), you can do simply by holding cash in a money market. The money market adjusts nearly instantly to inflation, and the 68 day maturity (or Prime Money Market) is averaged against the maturity of the bonds in your fund or ladder.


The TIPS + MM reminds me of this thread. It may be of interest. It's where I learned some of the ideas that I have been supporting in this discussion.
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Post by tfb » Tue Mar 10, 2009 11:55 am

Gregory wrote:* I love the VIPSX = sausage analogy.

* Look at VIPSX's holdings: there's a few rungs missing! Not a good comparison to a rolling ladder where someone has purchased bonds yearly (or more often) and has a rung maturing yearly (or more often). Also, how can a fund that can hold up to 20% of non-TIPS investments be considered equivalent to a rolling pure bond fund?

Although officially VIPSX is actively managed and it may hold non-TIPS bonds, it has been nearly 100% in TIPS with substantially all the bonds on the market. There are only 28 bonds on the market. Vanguard fund owns 24. You can look at the current holdings on Vanguard's fund info page. The gap between 2018 and 2025 is not Vanguard's fault. Those bonds don't exist. Treasury just issued a 2019 bond this year. They will fill that gap over the next few years.
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Post by sewall » Tue Mar 10, 2009 12:44 pm

tfb wrote:Although officially VIPSX is actively managed and it may hold non-TIPS bonds, it has been nearly 100% in TIPS with substantially all the bonds on the market. There are only 28 bonds on the market. Vanguard fund owns 24. You can look at the current holdings on Vanguard's fund info page. The gap between 2018 and 2025 is not Vanguard's fault. Those bonds don't exist. Treasury just issued a 2019 bond this year. They will fill that gap over the next few years.


Thanks tfb.

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Post by Gregory » Tue Mar 10, 2009 1:10 pm

tfb wrote:Although officially VIPSX is actively managed and it may hold non-TIPS bonds, it has been nearly 100% in TIPS...
(bold added for emphasis) :D

So perhaps it's nearly ladder-like? :?: :wink:
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Post by sewall » Tue Mar 10, 2009 1:17 pm

Gregory wrote:
tfb wrote:Although officially VIPSX is actively managed and it may hold non-TIPS bonds, it has been nearly 100% in TIPS...
(bold added for emphasis) :D

So perhaps it's nearly ladder-like? :?: :wink:


A wobbly rope ladder? :?: :wink:
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Post by grayfox » Tue Mar 10, 2009 11:45 pm

tfb wrote:Although officially VIPSX is actively managed and it may hold non-TIPS bonds, it has been nearly 100% in TIPS with substantially all the bonds on the market. There are only 28 bonds on the market. Vanguard fund owns 24. You can look at the current holdings on Vanguard's fund info page. The gap between 2018 and 2025 is not Vanguard's fault. Those bonds don't exist. Treasury just issued a 2019 bond this year. They will fill that gap over the next few years.


How do you know what VIPSX holds? Vanguard only shows the holdings as of 12/31/2008. So they only tell you what the holdings were at the end of the quarter. In mutual fund parlance that is called window dressing.

I would like to know what it holds every day, especially the day I am buying so I know exactly what I am buying.

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Post by grayfox » Wed Mar 11, 2009 12:23 am

sewall wrote:We can certainly argue the differences and merits of a ladder vs fund and we have more to discuss when we talk about a specific fund like VIPSX.

But the bulk of the discussion and disagreement so far has been over a misunderstanding about NAV effects in a ladder and/or over lack of clarity in defining the terms of the debate.

I hope by now the facts that ladders have NAV fluctuations and that a rolling ladder can be identical to a fund is clear to all. The implication of these facts is that one cannot argue against a fund on NAV grounds alone. It is not a valid argument. Yet it is made all the time.


I guess we've knocked down that strawman. But that's not the argument for individual bonds.

Anyone that holds any individual TIPS knows that the market price fluctuates. All you have to do is log into your Vanguard account and you can see a new price everyday. In fact, I keep a spreadsheet of all my TIPS holdings and track them as if they were a mutual fund with NAV and number of shares. So the fact that a ladder has NAV fluctuations like a fund is no great revelation to anyone that has individual bonds.

So the argument is not that the NAV of a ladder doesn't fluctuate. The point is that each individual TIPS price on the maturity date is known with certainty. So if you have 50K TIPS maturing on 1/15/2014, 2015, 2016, and 2017 you know with 100% certainty that you will get exactly 50K real dollars on each of those dates.

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Post by tarnation » Wed Mar 11, 2009 12:47 am

sewall wrote:
I hope by now the facts that ladders have NAV fluctuations and that a rolling ladder can be identical to a fund is clear to all.

I hate to nitpick, but since you stressed the importance of being very precise, I must. To say they can be identical is not correct. Did you read the exchange between tfb and myself previously in this thread? Using his example, I show a result (that he agreed with) where under some (improbable) circumstances bonds funds behave MUCH differently than ladders.
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VIPSX liquidation

Post by Dan Kohn » Wed Mar 11, 2009 2:49 am

tarnation wrote:I hate to nitpick, but since you stressed the importance of being very precise, I must. To say they can be identical is not correct. Did you read the exchange between tfb and myself previously in this thread? Using his example, I show a result (that he agreed with) where under some (improbable) circumstances bonds funds behave MUCH differently than ladders.

No, you misunderstood what tfb was saying.

If VIPSX liquidates, to get your money back, you need to either 1) buy a set of bonds equivalent to what it held the day before or 2) buy a zero-coupon bond with a face value equal to your original principal. In either case, you are no worse off. But the chances of VIPSX liquidating are basically nil, so the whole example is pretty pointless.

Guys, this feels like arguing a 2nd amendment issue. No one is going to come into your home and take away your bond ladders! No one is arguing that there is anything wrong with bond ladders (other than the time they take to set up and manage, and that dividends cannot easily be reinvested, and that they don't deal with fractional purchases and redemptions well). Certainly, I think people like you and tfb find bond ladders intellectually engaging, so the time it takes to set up and manage is not really a cost. More power to you.

But the conclusion remains that rolling bond ladders are no more or less volatile than a bond fund with an equivalent duration. If you are worried about the 24% NAV drop in VIPSX in 2008 (which is only if you bought and sold on the two worst days), then you shouldn't own a rolling ladder of TIPS at all, because that was just an effect of the underlying volatility of the bonds. But the NAV of your ladder dropped the same amount.

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ladders

Post by Dan Kohn » Wed Mar 11, 2009 3:04 am

grayfox wrote:So the argument is not that the NAV of a ladder doesn't fluctuate. The point is that each individual TIPS price on the maturity date is known with certainty. So if you have 50K TIPS maturing on 1/15/2014, 2015, 2016, and 2017 you know with 100% certainty that you will get exactly 50K real dollars on each of those dates.

I still don't think you get the point. Are you spending that full $50 K each year, or are you rolling over half of it? That's the critical distinction.

If you're spending it all, than you are building a non-rolling bond ladder to satisfy a set of date-certain future liabilities. And there is nothing better than a non-rolling ladder of TIPS to satisfy known future real liabilities.

But if you are planning to reinvest (i.e, rollover) some of the $50 K into a new individual TIPS bond, then you have gained nothing by using a rolling ladder over a fund. Because not rolling over the whole bond at the (hypothetically) very high yield has an identical opportunity cost to selling a portion of your fund at the (hypothetically) very low NAV.

So, the real issue is whether you have a rolling or a non-rolling ladder, not between a rolling ladder and a fund.

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Post by grayfox » Wed Mar 11, 2009 6:17 am

Well I am talking about a TIPS ladder for retirement spending. In the ideal case you would buy a 40K face value TIPS for each of the next 1 to 30 years. Each year you would have 40K to spend. It has been shown that as long as the real yield is 1.31% you have 4% SWR with 100% success rate.

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