Larry Swedroe: Understanding TIPS

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Random Walker
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Larry Swedroe: Understanding TIPS

Post by Random Walker » Fri Dec 07, 2018 10:47 am

https://www.etf.com/sections/index-inve ... nopaging=1

EXCELLENT explanation of TIPS v. Nominal Bonds. The difference in yield between the two is not the expected inflation rate: liquidity and risk premia for unexpected inflation play into the difference as well. Larry also discusses individual bonds v. Bond funds, CDs as alternatives, and the allocation decision between TIPS and nominal.

Dave

mervinj7
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Re: Larry Swedroe: Understanding TIPS

Post by mervinj7 » Fri Dec 07, 2018 11:23 am

Excellent article. I think I have a slightly better understanding of TIPS now. I will continue, as previously planned, to buy the 5 Year TIPS in my HSA next week.
Last edited by mervinj7 on Fri Dec 07, 2018 11:36 am, edited 1 time in total.

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Re: Larry Swedroe: Understanding TIPS

Post by marcopolo » Fri Dec 07, 2018 11:26 am

Very helpful, and timely for me, article.
I about to rollover a 401k with sizable allocation to Total Bond fund (all nominal treasuries).
Now that I have broader set of options, I have been considering splitting it up between CDs, Nominal bonds, and TIPs.
This article confirms my thinking on at least getting away from almost all Nominal bonds (have some other CDs currently, but no TIPS).
Now i just have to decide how much to of my fixed income to allocate to each option. Lots of good info in the article, and the sources cited.

Thanks for posting
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Re: Larry Swedroe: Understanding TIPS

Post by snailderby » Fri Dec 07, 2018 11:35 am

I never understood TIPS. Still don't fully understood them. But this article was helpful. Thank you for sharing this, Dave!

CULater
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Re: Larry Swedroe: Understanding TIPS

Post by CULater » Fri Dec 07, 2018 12:00 pm

Great informative article as usual from Larry. I'd like to see his analysis of i-Bonds as an alternative to TIPS.
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Re: Larry Swedroe: Understanding TIPS

Post by garlandwhizzer » Fri Dec 07, 2018 12:19 pm

Good article. Vanguard ST TIPS Fund has been the only bond fund I have owned over the last year, the rest of my fixed income in MMF with zero duration. In periods of rising rates and rising inflation, which we have had for more than a year, TIPS and shortest duration tend to outperform longer duration nominal bonds. I believe, however, it is likely that both rising inflation and rising rates will moderate, disappear, or reverse next year. Time will tell. I believe in making occasional/rare bond portfolio adjustments as market conditions change.

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Re: Larry Swedroe: Understanding TIPS

Post by CULater » Fri Dec 07, 2018 12:22 pm

garlandwhizzer wrote:
Fri Dec 07, 2018 12:19 pm
Good article. Vanguard ST TIPS Fund has been the only bond fund I have owned over the last year, the rest of my fixed income in MMF with zero duration. In periods of rising rates and rising inflation, which we have had for more than a year, TIPS and shortest duration tend to outperform longer duration nominal bonds. I believe, however, it is likely that both rising inflation and rising rates will moderate, disappear, or reverse next year. Time will tell. I believe in making occasional/rare bond portfolio adjustments as market conditions change.

Garland Whizzer
I'm with you on that.
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Re: Larry Swedroe: Understanding TIPS

Post by kolea » Fri Dec 07, 2018 12:25 pm

I have become a big proponent of TIPS, the bonds not the funds. I have been building a ladder of 5-year TIPS and this is largely replacing my TBM fund.
Kolea (pron. ko-lay-uh). Golden plover.

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Re: Larry Swedroe: Understanding TIPS

Post by aj76er » Fri Dec 07, 2018 12:33 pm

I think the liquidity risk of TIPS goes understated (refer to 2008, when it showed up at exactly the wrong time).

Of course, there is a premium to be payed for the liquidity of nominal treasuries (as Swedroe points out). I think finding a balance between nominals and inflation-linked bonds is a personal decision and one should look at historical max draw down numbers to decide what percentage of nominal treasuries should be held in a portfolio.

Along the same lines, one gives up a lot of liquidity with brokered CDs, so it's only a partial free lunch. Direct CDs (with favorable EWP) don't have this issue, making them closer to a real free lunch :).

Finally, holding a balanced investment grade bond fund (e.g. Total Bond Mkt) seems like a reasonable way to increase nominal yields to overcome liquidity premia that comes with 100% nominal treasuries.
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Re: Larry Swedroe: Understanding TIPS

Post by galeno » Fri Dec 07, 2018 12:42 pm

We hold 15% of port in a TIPS ETF (duration = 7.8 yr). Its purpose is to protect 25% of our 60% of port FI allocation against unexpected inflation.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Larry Swedroe: Understanding TIPS

Post by ebrasmus21 » Fri Dec 07, 2018 1:11 pm

mervinj7 wrote:
Fri Dec 07, 2018 11:23 am
Excellent article. I think I have a slightly better understanding of TIPS now. I will continue, as previously planned, to buy the 5 Year TIPS in my HSA next week.
For my HSA I have access to two VG TIPS funds

- VTAPX (short-term 2.6 avg duration)
- VIPIX (7 yr avg duration)

Any insights on using one vs the other?

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Re: Larry Swedroe: Understanding TIPS

Post by Day9 » Fri Dec 07, 2018 1:27 pm

I do a bond barbell with I-bonds as my short duration bonds, and longer term treasuries as my longer duration bonds. It works for me. But I think that any of the Boglehead-endorsed fixed-income strategies are almost nearly as good as each other. Total Bond, Intermediate high quality bonds, Intermediate Treasuries, TIPS, or CDs (Mr Swedroe mentions how CDs have higher yield than same duration Treasuries in this article)
Last edited by Day9 on Fri Dec 07, 2018 2:27 pm, edited 1 time in total.
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Re: Larry Swedroe: Understanding TIPS

Post by ionball » Fri Dec 07, 2018 1:30 pm

ebrasmus21 wrote:
Fri Dec 07, 2018 1:11 pm
mervinj7 wrote:
Fri Dec 07, 2018 11:23 am
Excellent article. I think I have a slightly better understanding of TIPS now. I will continue, as previously planned, to buy the 5 Year TIPS in my HSA next week.
For my HSA I have access to two VG TIPS funds

- VTAPX (short-term 2.6 avg duration)
- VIPIX (7 yr avg duration)

Any insights on using one vs the other?
I try to blend the two funds to match my spending duration forecasts. Not sure how well that would work for HSA needs since forecasting of spending may tend to be unpredictable. Perhaps lean toward the short duration fund to account for near term surprises.

ebrasmus21
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Re: Larry Swedroe: Understanding TIPS

Post by ebrasmus21 » Fri Dec 07, 2018 1:41 pm

ionball wrote:
Fri Dec 07, 2018 1:30 pm
ebrasmus21 wrote:
Fri Dec 07, 2018 1:11 pm
mervinj7 wrote:
Fri Dec 07, 2018 11:23 am
Excellent article. I think I have a slightly better understanding of TIPS now. I will continue, as previously planned, to buy the 5 Year TIPS in my HSA next week.
For my HSA I have access to two VG TIPS funds

- VTAPX (short-term 2.6 avg duration)
- VIPIX (7 yr avg duration)

Any insights on using one vs the other?
I try to blend the two funds to match my spending duration forecasts. Not sure how well that would work for HSA needs since forecasting of spending may tend to be unpredictable. Perhaps lean toward the short duration fund to account for near term surprises.
Thank you. I do plan on using the HSA funds for current needs, as they arise. I'd just like to explore options other than my cash position as a CA resident.

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Re: Larry Swedroe: Understanding TIPS

Post by Ben Mathew » Fri Dec 07, 2018 2:51 pm

I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?

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Re: Larry Swedroe: Understanding TIPS

Post by kolea » Fri Dec 07, 2018 3:22 pm

aj76er wrote:
Fri Dec 07, 2018 12:33 pm
I think the liquidity risk of TIPS goes understated (refer to 2008, when it showed up at exactly the wrong time).
Yes but if you understand your liquidity needs that problem can be obviated. We ladder TIPS so are never more than 1 year away from one rung maturing, and we keep about 1 year worth of cash and also have about 5% in VGSH (Vanguard short government bond fund). I feel pretty good about our liquidity.
Kolea (pron. ko-lay-uh). Golden plover.

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Re: Larry Swedroe: Understanding TIPS

Post by Random Walker » Fri Dec 07, 2018 3:29 pm

Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
My understanding of bonds is quite limited, so maybe shouldn’t be commenting, but heck, it’s the Internet. The difference between TIPS yield and Nominal yield has three components: expected inflation, risk premium for unexpected inflation, liquidity premium. We can get a very good feel for expected inflation, but I think how to divide up the remainder of difference between TIPS and Nominal yields between premiums for unexpected inflation and liquidity could be more challenging or not possible. A good starting point might be to look at the yield spread between treasuries and FDIC insured CDs of equal maturity. In this case, from my point of view,both are riskless and you’d be isolating the liquidity premium.

Dave

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FIREchief
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Re: Larry Swedroe: Understanding TIPS

Post by FIREchief » Fri Dec 07, 2018 11:02 pm

I think that way too much focus is given to the "liquidity premium." If it truly does exist, it is miniscule. These are US treasuries that are bought and sold by millions of individuals and institutions. 2008 was an isolated data point that rapidly faded to irrelevance.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

jalbert
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Re: Larry Swedroe: Understanding TIPS

Post by jalbert » Fri Dec 07, 2018 11:56 pm

Some minor additional points come to mind.

First, if a 401K plan has a brokerage option, individual TIPS can be purchased there.

Second, if holding TIPS in a taxable account, a TIPS funds distribute the inflation correction to principal so that you are not paying tax on income you have no way to receive other than by selling a TIPS or having it nature.

Third, low cost TIPS funds are available as mutual funds so that bid-ask spreads of ETFs may be avoided:

VTAPX duration of 2.5 years, ER = .06%
FIPDX duration of 5.2 years, ER = .05%
VAIPX duration range 7-8.5 years, ER = .1%
duration of VAIPX changes due to active mgmt.
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Re: Larry Swedroe: Understanding TIPS

Post by FIREchief » Sat Dec 08, 2018 12:25 am

jalbert wrote:
Fri Dec 07, 2018 11:56 pm
Some minor additional points come to mind.

First, if a 401K plan has a brokerage option, individual TIPS can be purchased there.
Oddly enough, my former Megacorp 401k with Fido did have a brokeragelink component, but it did not allow the purchase of individual TIPS.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Understanding TIPS

Post by Prokofiev » Sat Dec 08, 2018 1:19 am

kolea wrote:
Fri Dec 07, 2018 12:25 pm
I have become a big proponent of TIPS, the bonds not the funds. I have been building a ladder of 5-year TIPS and this is largely replacing my TBM fund.
That seems to be a very short ladder.
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Re: Larry Swedroe: Understanding TIPS

Post by grok87 » Sat Dec 08, 2018 7:23 am

Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
It's a good question. it doesn't seem like it would be that hard to do.
Keep calm and Boglehead on. KCBO.

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Re: Larry Swedroe: Understanding TIPS

Post by grok87 » Sat Dec 08, 2018 7:30 am

FIREchief wrote:
Fri Dec 07, 2018 11:02 pm
I think that way too much focus is given to the "liquidity premium." If it truly does exist, it is miniscule. These are US treasuries that are bought and sold by millions of individuals and institutions. 2008 was an isolated data point that rapidly faded to irrelevance.
my estimate of the il-liquidity premium for long term tips is about 25 bps as discussed here.
viewtopic.php?f=10&t=265669
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Re: Larry Swedroe: Understanding TIPS

Post by Doc » Sat Dec 08, 2018 9:17 am

FIREchief wrote:
Fri Dec 07, 2018 11:02 pm
I think that way too much focus is given to the "liquidity premium." If it truly does exist, it is miniscule. These are US treasuries that are bought and sold by millions of individuals and institutions. 2008 was an isolated data point that rapidly faded to irrelevance.
We don't know that will be irrelevant in the next market crash. Our entire ten year TIPS was sold to rebalance in '08. If you use Treasuries as the rebalancing allotment of your portfolio for potential market crashes that allotment should be in nominals. TIPS should be used only for that part of your portfolio that you are going to use for expenses far in the future.

Of course if your IPS says sell stock when the market crashes TIPS would he just fine. :wink:
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Re: Larry Swedroe: Understanding TIPS

Post by grok87 » Sat Dec 08, 2018 9:58 am

Random Walker wrote:
Fri Dec 07, 2018 3:29 pm
Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
My understanding of bonds is quite limited, so maybe shouldn’t be commenting, but heck, it’s the Internet. The difference between TIPS yield and Nominal yield has three components: expected inflation, risk premium for unexpected inflation, liquidity premium. We can get a very good feel for expected inflation, but I think how to divide up the remainder of difference between TIPS and Nominal yields between premiums for unexpected inflation and liquidity could be more challenging or not possible. A good starting point might be to look at the yield spread between treasuries and FDIC insured CDs of equal maturity. In this case, from my point of view,both are riskless and you’d be isolating the liquidity premium.

Dave
a complicating factor for CD yields is state taxes
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Re: Larry Swedroe: Understanding TIPS

Post by MCSquared » Sat Dec 08, 2018 10:20 am

Random Walker wrote:
Fri Dec 07, 2018 3:29 pm
Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
My understanding of bonds is quite limited, so maybe shouldn’t be commenting, but heck, it’s the Internet. The difference between TIPS yield and Nominal yield has three components: expected inflation, risk premium for unexpected inflation, liquidity premium. We can get a very good feel for expected inflation, but I think how to divide up the remainder of difference between TIPS and Nominal yields between premiums for unexpected inflation and liquidity could be more challenging or not possible. A good starting point might be to look at the yield spread between treasuries and FDIC insured CDs of equal maturity. In this case, from my point of view,both are riskless and you’d be isolating the liquidity premium.

Dave
Except I am not certain that you are isolating just the liquidity premium when examining the spread between treasuries and FDIC insured/guaranteed debt. If I recall, in 2008 the FDIC explicitly guaranteed certain bank debt under TLGP and when that debt initially traded it was roughly 300-400 basis points wider than corresponding treasury debt. Do you think that was all liquidity related? I know spreads came way down as time progressed.

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Re: Larry Swedroe: Understanding TIPS

Post by Ben Mathew » Sat Dec 08, 2018 12:01 pm

Random Walker wrote:
Fri Dec 07, 2018 3:29 pm
Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
My understanding of bonds is quite limited, so maybe shouldn’t be commenting, but heck, it’s the Internet. The difference between TIPS yield and Nominal yield has three components: expected inflation, risk premium for unexpected inflation, liquidity premium. We can get a very good feel for expected inflation, but I think how to divide up the remainder of difference between TIPS and Nominal yields between premiums for unexpected inflation and liquidity could be more challenging or not possible. A good starting point might be to look at the yield spread between treasuries and FDIC insured CDs of equal maturity. In this case, from my point of view,both are riskless and you’d be isolating the liquidity premium.

Dave
I am a bit skeptical of the expected inflation estimates--they may be accurate, I just can't be sure. So I was hoping to use realized inflation and yields instead. If the

expected real yield of TIPS > expected real yield of nominal

then, on average, the

realized real yield of TIPS > realized real yield of nominal

This should hold unless actual inflation consistently turned out to be lower than expected and caused nominals to outperform. It should be a pretty easy analysis to do. We wouldn't need estimates for inflation expectations, liquidity premiums, or inflation risk premiums. Just realized inflation and realized yields. The Fed probably publishes these numbers.

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Re: Larry Swedroe: Understanding TIPS

Post by Ben Mathew » Sat Dec 08, 2018 12:10 pm

FIREchief wrote:
Fri Dec 07, 2018 11:02 pm
I think that way too much focus is given to the "liquidity premium." If it truly does exist, it is miniscule. These are US treasuries that are bought and sold by millions of individuals and institutions. 2008 was an isolated data point that rapidly faded to irrelevance.
That would be my guess too. Protection against inflation risk seems like a much bigger deal than a small reduction in liquidity.

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Re: Larry Swedroe: Understanding TIPS

Post by Doc » Sat Dec 08, 2018 12:25 pm

Ben Mathew wrote:
Sat Dec 08, 2018 12:10 pm
FIREchief wrote:
Fri Dec 07, 2018 11:02 pm
I think that way too much focus is given to the "liquidity premium." If it truly does exist, it is miniscule. These are US treasuries that are bought and sold by millions of individuals and institutions. 2008 was an isolated data point that rapidly faded to irrelevance.
That would be my guess too. Protection against inflation risk seems like a much bigger deal than a small reduction in liquidity.
Small?

TIPS (VAIPX)and nominal fund (VFIUX) prices in '08:

Image

http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D
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Re: Larry Swedroe: Understanding TIPS

Post by Ben Mathew » Sat Dec 08, 2018 12:28 pm

grok87 wrote:
Sat Dec 08, 2018 7:23 am
Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
It's a good question. it doesn't seem like it would be that hard to do.
The data should be easily available, maybe from the Fed website. I was hoping that someone can point to a study that does this. If not, it should be worth digging up these numbers.

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Re: Larry Swedroe: Understanding TIPS

Post by metalworking » Sat Dec 08, 2018 12:36 pm

When I read this article it makes me wonder if i do indeed need a financial advisor. Too many things i do not know.

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Re: Larry Swedroe: Understanding TIPS

Post by FIREchief » Sat Dec 08, 2018 2:32 pm

Doc wrote:
Sat Dec 08, 2018 9:17 am
Our entire ten year TIPS was sold to rebalance in '08. If you use Treasuries as the rebalancing allotment of your portfolio for potential market crashes that allotment should be in nominals.


Fair point. I use an LMP/RP strategy and never rebalance, so it's a non-issue in my situation.
TIPS should be used only for that part of your portfolio that you are going to use for expenses far in the future.
Why "far in the future?" A rolling TIPS ladder that has maturing issues every calendar year works just fine for near, mid and far future points.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Understanding TIPS

Post by Doc » Sat Dec 08, 2018 3:03 pm

FIREchief wrote:
Sat Dec 08, 2018 2:32 pm
TIPS should be used only for that part of your portfolio that you are going to use for expenses far in the future.
Why "far in the future?" A rolling TIPS ladder that has maturing issues every calendar year works just fine for near, mid and far future points.
Near term "withdrawals" can be met with little inflation risk by nominal notes. The further out you go the more the inflation risk could bite you and therefore TIPS give you some insurance. I was thinking of far in the future as bonds and near and mid as notes.

If I was starting to build Grok's 30 year TIPS retirement ladder today I would be buying five's for the next five years and then in year six roll the maturing not and buy my normal annual contribution at that time. I would extend the maturity of newly purchased notes as the yield curve at the time of the new purchase or the roll over of existing notes dictate.
FIREchief wrote:
Sat Dec 08, 2018 2:32 pm
... and never rebalance ...
That's a concept that I have never even considered and am unlikely to. The whole point of a TIPS ladder for retirement is to reduce risk. Why would you let your portfolio become more risky by never rebalancing and just let your equity portion increase with no limit.
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Re: Larry Swedroe: Understanding TIPS

Post by FIREchief » Sat Dec 08, 2018 9:58 pm

Doc wrote:
Sat Dec 08, 2018 3:03 pm
FIREchief wrote:
Sat Dec 08, 2018 2:32 pm
... and never rebalance ...
That's a concept that I have never even considered and am unlikely to. The whole point of a TIPS ladder for retirement is to reduce risk. Why would you let your portfolio become more risky by never rebalancing and just let your equity portion increase with no limit.
Ability and willingness to take risk (for my heirs)...…

btw: "increase with no limit" sounds more positive than negative. 8-)
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Re: Larry Swedroe: Understanding TIPS

Post by FIREchief » Sat Dec 08, 2018 10:05 pm

Also, Doc: a belated thanks for a discussion several years ago when you helped me to see the light wrt the lack of any real "rebalancing premium." I think I soon after migrated towards the LMP/RP strategy for my situation. I was likely a boglehead for decades before I found the forum soon after FIRE in 2015. Right, wrong or whatever; around 1990 I just started sticking 100% into S&P 500 index funds and focused my energies on the rest of life that was happening. 30 years later, I have no regrets!! :sharebeer
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Re: Larry Swedroe: Understanding TIPS

Post by Ben Mathew » Mon Dec 10, 2018 1:22 am

grok87 wrote:
Sat Dec 08, 2018 7:23 am
Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
It's a good question. it doesn't seem like it would be that hard to do.
Here's a stab at it. I'm not an expert on bonds, and I didn't take the time to understand all the nuances of the data, so I may have made some blunders. If you see major problems, please me know.

To summarize the analysis: The article makes the claim that the illiquidity premium for TIPS > inflation risk premium for nominal treasuries. So

expected real yield of TIPS > expected real yield of nominal

If that's true, then, on average, unless actual inflation consistently turns out to be less than expected, the

realized real yield of TIPS > realized real yield of nominal

I'm trying to test this implication about realized yields.

Data is monthly yields (average of daily yields) from 2003 onwards for

10 year TIPS (Data: https://fred.stlouisfed.org/series/FII10)
vs
10 year nominal treasuries (Data: https://fred.stlouisfed.org/series/GS10)

Inflation index: CPI Urban consumers (https://beta.bls.gov/dataViewer/view/ti ... UUR0000SA0)

I don't know why this TIPS data series starts only in Jan 2003, when 10 year TIPS were first issued In Jan 1997. That gives me only 6 years of data points because I can only go up to Oct 2008 (last month for which I can calculate 10 year realized inflation). During that time, I find that the realized real yields of nominals were usually higher than that of TIPS. So this does not offer support for the claim that TIPS should have higher expected yield. But, of course, it's a short time frame.

Image

Couple of issues in this analysis:

(1) These are not zero coupon yields. I think the yields are based on semi-annual coupons, but I have not done any adjustments for that.
(2) Using average monthly yields instead of daily yields is a little sloppy

Let me know if there are other problems.

Here's the spreadsheet.

grok87
Posts: 8504
Joined: Tue Feb 27, 2007 9:00 pm

Re: Larry Swedroe: Understanding TIPS

Post by grok87 » Tue Dec 11, 2018 7:44 am

Ben Mathew wrote:
Mon Dec 10, 2018 1:22 am
grok87 wrote:
Sat Dec 08, 2018 7:23 am
Ben Mathew wrote:
Fri Dec 07, 2018 2:51 pm
I'm surprised by the claim that TIPS has an expected real yield greater than nominal bonds because the liquidity premium for TIPS > the inflation risk premium for nominal bonds. If that's true, then the case for TIPS over nominal would be very strong for long term investors who don't need much liquidity. Is there a clean empirical comparison of historical realized yields of TIPS vs nominal treasuries of the same maturity that supports this claim?
It's a good question. it doesn't seem like it would be that hard to do.
Here's a stab at it. I'm not an expert on bonds, and I didn't take the time to understand all the nuances of the data, so I may have made some blunders. If you see major problems, please me know.

To summarize the analysis: The article makes the claim that the illiquidity premium for TIPS > inflation risk premium for nominal treasuries. So

expected real yield of TIPS > expected real yield of nominal

If that's true, then, on average, unless actual inflation consistently turns out to be less than expected, the

realized real yield of TIPS > realized real yield of nominal

I'm trying to test this implication about realized yields.

Data is monthly yields (average of daily yields) from 2003 onwards for

10 year TIPS (Data: https://fred.stlouisfed.org/series/FII10)
vs
10 year nominal treasuries (Data: https://fred.stlouisfed.org/series/GS10)

Inflation index: CPI Urban consumers (https://beta.bls.gov/dataViewer/view/ti ... UUR0000SA0)

I don't know why this TIPS data series starts only in Jan 2003, when 10 year TIPS were first issued In Jan 1997. That gives me only 6 years of data points because I can only go up to Oct 2008 (last month for which I can calculate 10 year realized inflation). During that time, I find that the realized real yields of nominals were usually higher than that of TIPS. So this does not offer support for the claim that TIPS should have higher expected yield. But, of course, it's a short time frame.

Image

Couple of issues in this analysis:

(1) These are not zero coupon yields. I think the yields are based on semi-annual coupons, but I have not done any adjustments for that.
(2) Using average monthly yields instead of daily yields is a little sloppy

Let me know if there are other problems.

Here's the spreadsheet.
Thanks. I’ll take a look when I get a chance.
Keep calm and Boglehead on. KCBO.

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