Now that long TIPS yields have breached 2.25% again I will…

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GP813
Posts: 1254
Joined: Wed Dec 11, 2019 9:11 am

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by GP813 »

evancox10 wrote: Wed Mar 27, 2024 11:32 pm

IANAEconomist, but I believe you are describing changes in productivity which would show up as increased real growth of the economy, ie after adjusting nominal GDP for inflation. There is no direct relationship between changes in real GDP and inflation. (There are correlations, both high inflation and deflation are in general not good for real economic growth.)

Of course productivity increases are deflationary on their own, but central banks don't stand still while prices are changing. If your proposed revolution in energy production decreases the price of energy, then the central bank is going to step on the monetary gas pedal a little harder so that the price of everything else rises just a little more than it otherwise would have. That way the price of the overall basket of goods doesn’t fall, even though the price of energy relative to the price of, say, bananas, has decreased.

(Note: I’m not getting into the fiscal, ie government spending side, which is what people love to focus on. That will absolutely have effects on prices, wages, etc., but again the central bank is, in theory, counteracting whatever the fiscal side is doing, so as to maintain the central bank’s inflation target. This falls apart when the economy is severely understimulated, the central bank can only drop rates so low before it just doesn’t work. The famous “pushing on a string” problem post GFC.)
Inflation is complicated with a lot of moving parts but by reducing unit labor cost increases, productivity growth reduces inflationary pressure on prices. Another factor of inflation is input costs, so if energy prices increase they are reflected in the prices people eventually pay for everything, the opposite is also true.

This thread is about TIPS so I don't want to get to into the weeds but there are many comments saying that high inflation is certain and I think that's not a very balanced long term view.
loukycpa
Posts: 789
Joined: Wed Aug 05, 2020 9:52 am

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
km91
Posts: 1393
Joined: Wed Oct 13, 2021 12:32 pm

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by km91 »

loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Price is per $100 of face value. Your purchase cost is calculated as $ par x price/100 x inflation index = 64,000 x 0.8919 x 1.18374 = ~$67,500

64,000 x index is inflation adjusted dollars. In 2031 you will have purchasing power equivalent to $64,000 in today's dollars
loukycpa
Posts: 789
Joined: Wed Aug 05, 2020 9:52 am

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

km91 wrote: Thu Mar 28, 2024 11:14 am
loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Price is per $100 of face value. Your purchase cost is calculated as $ par x price/100 x inflation index = 64,000 x 0.8919 x 1.18374 = ~$67,500

64,000 x index is inflation adjusted dollars. In 2031 you will have purchasing power equivalent to $64,000 in today's dollars
In my mind, what was $64k in purchasing power in 2021 dollars has become $75k in 2024 dollars. Because of how interest rates have increased, the price of the bond has decreased. So I am able to buy $75k in purchasing power (in 2024 dollars) at a discount of $8k rounded. Said differently I will earn the $8k as a real yield over the course of the next 7 years if I hold to maturity.

Do I have the wrong idea?

The way you framed it doesn't seem right to me. Why would I pay $67,500 for $64k in purchasing power in today's dollars? Where would I get my real yield I am expecting of 2% if that were true? I think the $64k has to be thought of as 2021 dollars. These are 10 year TIPS. I purchased in secondary market not at auction.
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
km91
Posts: 1393
Joined: Wed Oct 13, 2021 12:32 pm

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by km91 »

loukycpa wrote: Thu Mar 28, 2024 12:01 pm
km91 wrote: Thu Mar 28, 2024 11:14 am
loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Price is per $100 of face value. Your purchase cost is calculated as $ par x price/100 x inflation index = 64,000 x 0.8919 x 1.18374 = ~$67,500

64,000 x index is inflation adjusted dollars. In 2031 you will have purchasing power equivalent to $64,000 in today's dollars
In my mind, what was $64k in purchasing power in 2021 dollars has become $75k in 2024 dollars. Because of how interest rates have increased, the price of the bond has decreased. So I am able to buy $75k in purchasing power (in 2024 dollars) at a discount of $8k rounded. Said differently I will earn the $8k as a real yield over the course of the next 7 years if I hold to maturity.

Do I have the wrong idea?

The way you framed it doesn't seem right to me. Why would I pay $67,500 for $64k in purchasing power in today's dollars? Where would I get my real yield I am expecting of 2% if that were true? I think the $64k has to be thought of as 2021 dollars. These are 10 year TIPS. I purchased in secondary market not at auction.
You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
loukycpa
Posts: 789
Joined: Wed Aug 05, 2020 9:52 am

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

km91 wrote: Thu Mar 28, 2024 2:05 pm
loukycpa wrote: Thu Mar 28, 2024 12:01 pm
km91 wrote: Thu Mar 28, 2024 11:14 am
loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Price is per $100 of face value. Your purchase cost is calculated as $ par x price/100 x inflation index = 64,000 x 0.8919 x 1.18374 = ~$67,500

64,000 x index is inflation adjusted dollars. In 2031 you will have purchasing power equivalent to $64,000 in today's dollars
In my mind, what was $64k in purchasing power in 2021 dollars has become $75k in 2024 dollars. Because of how interest rates have increased, the price of the bond has decreased. So I am able to buy $75k in purchasing power (in 2024 dollars) at a discount of $8k rounded. Said differently I will earn the $8k as a real yield over the course of the next 7 years if I hold to maturity.

Do I have the wrong idea?

The way you framed it doesn't seem right to me. Why would I pay $67,500 for $64k in purchasing power in today's dollars? Where would I get my real yield I am expecting of 2% if that were true? I think the $64k has to be thought of as 2021 dollars. These are 10 year TIPS. I purchased in secondary market not at auction.
You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
km91
Posts: 1393
Joined: Wed Oct 13, 2021 12:32 pm

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by km91 »

loukycpa wrote: Thu Mar 28, 2024 2:36 pm
km91 wrote: Thu Mar 28, 2024 2:05 pm
loukycpa wrote: Thu Mar 28, 2024 12:01 pm
km91 wrote: Thu Mar 28, 2024 11:14 am
loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Price is per $100 of face value. Your purchase cost is calculated as $ par x price/100 x inflation index = 64,000 x 0.8919 x 1.18374 = ~$67,500

64,000 x index is inflation adjusted dollars. In 2031 you will have purchasing power equivalent to $64,000 in today's dollars
In my mind, what was $64k in purchasing power in 2021 dollars has become $75k in 2024 dollars. Because of how interest rates have increased, the price of the bond has decreased. So I am able to buy $75k in purchasing power (in 2024 dollars) at a discount of $8k rounded. Said differently I will earn the $8k as a real yield over the course of the next 7 years if I hold to maturity.

Do I have the wrong idea?

The way you framed it doesn't seem right to me. Why would I pay $67,500 for $64k in purchasing power in today's dollars? Where would I get my real yield I am expecting of 2% if that were true? I think the $64k has to be thought of as 2021 dollars. These are 10 year TIPS. I purchased in secondary market not at auction.
You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
loukycpa
Posts: 789
Joined: Wed Aug 05, 2020 9:52 am

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm
km91 wrote: Thu Mar 28, 2024 2:05 pm
loukycpa wrote: Thu Mar 28, 2024 12:01 pm
km91 wrote: Thu Mar 28, 2024 11:14 am

Price is per $100 of face value. Your purchase cost is calculated as $ par x price/100 x inflation index = 64,000 x 0.8919 x 1.18374 = ~$67,500

64,000 x index is inflation adjusted dollars. In 2031 you will have purchasing power equivalent to $64,000 in today's dollars
In my mind, what was $64k in purchasing power in 2021 dollars has become $75k in 2024 dollars. Because of how interest rates have increased, the price of the bond has decreased. So I am able to buy $75k in purchasing power (in 2024 dollars) at a discount of $8k rounded. Said differently I will earn the $8k as a real yield over the course of the next 7 years if I hold to maturity.

Do I have the wrong idea?

The way you framed it doesn't seem right to me. Why would I pay $67,500 for $64k in purchasing power in today's dollars? Where would I get my real yield I am expecting of 2% if that were true? I think the $64k has to be thought of as 2021 dollars. These are 10 year TIPS. I purchased in secondary market not at auction.
You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
km91
Posts: 1393
Joined: Wed Oct 13, 2021 12:32 pm

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by km91 »

loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm
km91 wrote: Thu Mar 28, 2024 2:05 pm
loukycpa wrote: Thu Mar 28, 2024 12:01 pm

In my mind, what was $64k in purchasing power in 2021 dollars has become $75k in 2024 dollars. Because of how interest rates have increased, the price of the bond has decreased. So I am able to buy $75k in purchasing power (in 2024 dollars) at a discount of $8k rounded. Said differently I will earn the $8k as a real yield over the course of the next 7 years if I hold to maturity.

Do I have the wrong idea?

The way you framed it doesn't seem right to me. Why would I pay $67,500 for $64k in purchasing power in today's dollars? Where would I get my real yield I am expecting of 2% if that were true? I think the $64k has to be thought of as 2021 dollars. These are 10 year TIPS. I purchased in secondary market not at auction.
You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
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Svensk Anga
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Svensk Anga »

km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm
km91 wrote: Thu Mar 28, 2024 2:05 pm

You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Loukycpa doesn't care about measuring in 2021 dollars. His baseline is 2024. He will earn about 1.8% real from here. Part of that return is the puny coupon of 0.125%. The remainder is real yield which will increase the purchasing power of his investment by a factor of 1/0.8919 or 12%. He will indeed have $75K of purchasing power measured in 2024 dollars.

km91 got hosed by selling this bond for only 0.8919. His real yield was negative. You say it was sold for $67k, but that is $67k in 2024 dollars. it was sold for 0.8919 x $64k or $57k in 2021 dollars. km91's loss is loukycpa's gain.
km91
Posts: 1393
Joined: Wed Oct 13, 2021 12:32 pm

Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by km91 »

Svensk Anga wrote: Thu Mar 28, 2024 7:50 pm
km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm

It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Loukycpa doesn't care about measuring in 2021 dollars. His baseline is 2024. He will earn about 1.8% real from here. Part of that return is the puny coupon of 0.125%. The remainder is real yield which will increase the purchasing power of his investment by a factor of 1/0.8919 or 12%. He will indeed have $75K of purchasing power measured in 2024 dollars.

km91 got hosed by selling this bond for only 0.8919. His real yield was negative. You say it was sold for $67k, but that is $67k in 2024 dollars. it was sold for 0.8919 x $64k or $57k in 2021 dollars. km91's loss is loukycpa's gain.
This is incorrect. If this bond was bought in 2024 it does not maintain $64k x 1.1873 = $75,750 of principal purchasing power. It maintains purchasing power of $64,000 in 2024 dollars, and earns a 2% real yield
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Svensk Anga
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Svensk Anga »

km91 wrote: Thu Mar 28, 2024 9:15 pm
Svensk Anga wrote: Thu Mar 28, 2024 7:50 pm
km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm

The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Loukycpa doesn't care about measuring in 2021 dollars. His baseline is 2024. He will earn about 1.8% real from here. Part of that return is the puny coupon of 0.125%. The remainder is real yield which will increase the purchasing power of his investment by a factor of 1/0.8919 or 12%. He will indeed have $75K of purchasing power measured in 2024 dollars.

km91 got hosed by selling this bond for only 0.8919. His real yield was negative. You say it was sold for $67k, but that is $67k in 2024 dollars. it was sold for 0.8919 x $64k or $57k in 2021 dollars. km91's loss is loukycpa's gain.
This is incorrect. If this bond was bought in 2024 it does not maintain $64k x 1.1873 = $75,750 of principal purchasing power. It maintains purchasing power of $64,000 in 2024 dollars, and earns a 2% real yield
Most of that real yield comes in the form of appreciation of the principal value, since the coupon is so small.

He bought it for $67,400 in 2024 dollars. He could have spent that 67.4k on anything else you can get for 67.4k in 2024 so that is the value of the asset as of the date of purchase in 2024 dollars. The Wall Street Journal reports that it will return 1.846% real from today. 0.125% is the annual coupon rate, so the principal will appreciate roughly 1.721%/year in real terms over its remaining life. Life is about 2.5 months short of 7 years so 6.79 years. $67,400 x 1.01721^6.79 = $75,679 is the value at maturity of the principal in 2024 dollars. He also gets some coupon payments along the way, not that they amount to much. Equivalently, he would get the value of $64,000 in 2021 dollars which is 64,000 x 1.184 = $75,776 in March 28, 2024 dollars.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Lyrrad »

km91 wrote: Thu Mar 28, 2024 9:15 pm This is incorrect. If this bond was bought in 2024 it does not maintain $64k x 1.1873 = $75,750 of principal purchasing power. It maintains purchasing power of $64,000 in 2024 dollars, and earns a 2% real yield
I don't see how this statement can be correct.

Purchasing $64,000 in face value TIPS issued in 2021 when the inflation index ratio is 1.18374 in 2024, would mean that, ignoring coupon payments, one would get $64,000 in 2021 dollars or $75,759.36 in 2024 dollars at maturity.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm
km91 wrote: Thu Mar 28, 2024 2:05 pm

You are not buying $75,750 of purchasing power, you are buying $64k of purchasing power plus $11,750 (64,000 x (1.1873 -1)) of inflation accrual. The upfront cost you paid for the bond includes inflation adjustments that occurred while you did not own the bond. You will receive full adjusted principal at maturity, but a portion of the adjustment (1.1873 - 1) was not earned by you, it was earned by the seller of the bond
It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Because this issue and quantity of TIPS will always maintain the purchasing power of $64,000 in 2021 dollars. And the purchasing power of 64k in 2021 dollars is 75k in 2024 dollars.
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Dude2 »

I think this is why I just buy FIPDX.
Then ’tis like the breath of an unfee’d lawyer.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by CraigTester »

loukycpa wrote: Fri Mar 29, 2024 6:08 am
km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm

It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Because this issue and quantity of TIPS will always maintain the purchasing power of $64,000 in 2021 dollars. And the purchasing power of 64k in 2021 dollars is 75k in 2024 dollars.
I think the "blindspot" in the above exchange is not recognizing that the inflation adjustment factor compounds over time.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Your understanding is correct. You got some bad intel in some replies. If you don't trust me, you should trust forum member #Cruncher, who has been at this TIPS thing, and posting his TIPS wisdom on the forum, for many years. I am among many here who've learned a lot about TIPS from him.

#Cruncher has a TIPS ladder spreadsheet to help folks build TIPS ladders, which he first introduced to the forum in 2011. I have modified the spreadsheet to use TIPS quotes downloaded from Schwab, and I currently have the quotes from yesterday (Thursday) loaded. For a purchase yesterday, settlement is Monday April 1, due to the holiday today, so reference CPIs, and thus index ratios, are for 4/1/2024.

If I enter quantity 64 into the "already held" column for the Jan 31 TIPS row, it shows a "Real (4/1/2024) $ Rec'd" Principal value of 75,826, which of course is in the ballpark of the number you got from your correct calculation for the real principal as of 3/27/204 using the index ratio for that date. Incidentally, #Cruncher also has an excellent website where he provides lots of info on TIPS (and I bonds), and on that website we can look up the index ratios for the Jan 2031 TIPS for 2024 on this page. I see that the index ratio of 1.18374 is correct for March 27. For April 1, the settlement date I'm using, the index ratio is 1.18478.

The calculations used in the TIPS ladder spreadsheet to arrive at the 75,826 real principal value are as follows.
  1. Multiply the quantity, 64, by the principal value for one bond ($1,000 face value) on the "base date", which is the date you want to reference your real principal values to. I set the base date to the settlement date, which in this case is 4/1/2024. This principal value is 1,184.78.
  2. The principal value on the base date, 4/1/2024, is obtained by multiplying the face value of one bond, $1,000, by the ratio of the reference CPI values for 4/1/2024, 308.41700, and the dated date ref CPI, 260.31619, for this TIPS (the dated date is 1/15/2021), rounded to 5 decimal places. The latter is the index ratio, which is 308.41700/260.31619 = 1.18478. Note that this value agrees with the value shown on #Cruncher's website, as expected. Multiplying the IR by the $1,000 face value gives us the CPI adjusted principal of 1,184.78.
Regarding the pricing, this is standard bond pricing, where the price is a percent of par or face value. So a price of 89 is 89% of par, or $890 per $1,000 bond. Of course, as you understand, for TIPS you multiply this unadjusted price by the index ratio for the date of interest to get the adjusted price, which is the value of your TIPS on that date. Of course there is a bid price and ask price, so the value of interest depends on whether you are selling or buying.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

Svensk Anga wrote: Thu Mar 28, 2024 7:50 pm
km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm
loukycpa wrote: Thu Mar 28, 2024 2:36 pm

It doesn't matter who held the bond when the inflation adjustments happened, the owner of the bond at maturity will receive them.

I wouldn't disagree that the previous inflation adjustments are inherent in the price I paid, and in that sense they weren't "earned" by me. I had to pay for them. And thus now they are mine. If I hold it to maturity, I will receive all the inflation adjustments the bond produces, past and future.

On the other hand, because of the increase in interest rates between the date the bond was issued and today, I was able to buy it at a discount to the inflation adjusted principal and earn a real 2% yield as I hold it. Again, the difference between what I paid ($67k now vs. $75k at maturity) is where the real yield will come from.
The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Loukycpa doesn't care about measuring in 2021 dollars. His baseline is 2024. He will earn about 1.8% real from here. Part of that return is the puny coupon of 0.125%. The remainder is real yield which will increase the purchasing power of his investment by a factor of 1/0.8919 or 12%. He will indeed have $75K of purchasing power measured in 2024 dollars.

km91 got hosed by selling this bond for only 0.8919. His real yield was negative. You say it was sold for $67k, but that is $67k in 2024 dollars. it was sold for 0.8919 x $64k or $57k in 2021 dollars. km91's loss is loukycpa's gain.
Agree from an investment point of view buying this bond in 2024 I don't care about measuring in 2021 dollars, except in the mechanical sense of understanding the pricing.

As far as whether the seller of the bond is getting hosed, I would say it depends and time will tell. If the seller invests the money and earns more than 2% real between now and 2031 on the money, I suppose they are better off.
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

Kevin M wrote: Fri Mar 29, 2024 10:31 am
loukycpa wrote: Thu Mar 28, 2024 10:56 am I'm trying to learn to speak TIPS and could use some input from the experts here.

A couple of weeks ago I bought some of 91282CBF7, maturity date 1/15/2031. I paid about $67,400 (rounded). According to Vanguard this was for a quantity of 64,000. Price was $89.19. Coupon interest rate of .125%.

When I look up the inflation index ratio on Treasury Direct as of yesterday I see 1.18374. If I multiply 64,000 times that index I get somewhere around $75,750.

My questions:

1) I think what I can count on here in January 2031, ignoring any tax implications and also ignoring the small amount of cash flow from the semi annual coupon interest payments, is having the equivalent of $75,750 in purchasing power (in todays dollars). Is that correct?

2) Trying to understand the purchase price of $89.19, which it appears is now trading around $89.02. This seems to be per a quantity of 100? If I take the $75,750 times .8902, I get pretty close to what Vanguard tells me is the current value of $67.400. In my mind the roughly 2% real yield I will be earning if I hold it to maturity will bring me up to the $75,750 in purchasing power, which makes sense to me. I know of course when it matures I won't get $75,750 but instead this will be increasing with inflation over that time period.

Just checking to see if I am catching onto the basic mechanics of how TIPS work.
Your understanding is correct. You got some bad intel in some replies. If you don't trust me, you should trust forum member #Cruncher, who has been at this TIPS thing, and posting his TIPS wisdom on the forum, for many years. I am among many here who've learned a lot about TIPS from him.

#Cruncher has a TIPS ladder spreadsheet to help folks build TIPS ladders, which he first introduced to the forum in 2011. I have modified the spreadsheet to use TIPS quotes downloaded from Schwab, and I currently have the quotes from yesterday (Thursday) loaded. For a purchase yesterday, settlement is Monday April 1, due to the holiday today, so reference CPIs, and thus index ratios, are for 4/1/2024.

If I enter quantity 64 into the "already held" column for the Jan 31 TIPS row, it shows a "Real (4/1/2024) $ Rec'd" Principal value of 75,826, which of course is in the ballpark of the number you got from your correct calculation for the real principal as of 3/27/204 using the index ratio for that date. Incidentally, #Cruncher also has an excellent website where he provides lots of info on TIPS (and I bonds), and on that website we can look up the index ratios for the Jan 2031 TIPS for 2024 on this page. I see that the index ratio of 1.18374 is correct for March 27. For April 1, the settlement date I'm using, the index ratio is 1.18478.

The calculations used in the TIPS ladder spreadsheet to arrive at the 75,826 real principal value are as follows.
  1. Multiply the quantity, 64, by the principal value for one bond ($1,000 face value) on the "base date", which is the date you want to reference your real principal values to. I set the base date to the settlement date, which in this case is 4/1/2024. This principal value is 1,184.78.
  2. The principal value on the base date, 4/1/2024, is obtained by multiplying the face value of one bond, $1,000, by the ratio of the reference CPI values for 4/1/2024, 308.41700, and the dated date ref CPI, 260.31619, for this TIPS (the dated date is 1/15/2021), rounded to 5 decimal places. The latter is the index ratio, which is 308.41700/260.31619 = 1.18478. Note that this value agrees with the value shown on #Cruncher's website, as expected. Multiplying the IR by the $1,000 face value gives us the CPI adjusted principal of 1,184.78.
Regarding the pricing, this is standard bond pricing, where the price is a percent of par or face value. So a price of 89 is 89% of par, or $890 per $1,000 bond. Of course, as you understand, for TIPS you multiply this unadjusted price by the index ratio for the date of interest to get the adjusted price, which is the value of your TIPS on that date. Of course there is a bid price and ask price, so the value of interest depends on whether you are selling or buying.
Thanks Kevin M, very helpful. Thanks to everyone else as well. I'm finding that it takes some work to learn to speak TIPS but it isn't insurmountable. It is very helpful to have a village like this one to check and confirm understanding with.
"The safe assumption for an investor is that over the next hundred years, the currency is going to zero." - Charlie Munger
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Svensk Anga »

loukycpa wrote: Fri Mar 29, 2024 10:39 am
Svensk Anga wrote: Thu Mar 28, 2024 7:50 pm
km91 wrote: Thu Mar 28, 2024 5:44 pm
loukycpa wrote: Thu Mar 28, 2024 4:58 pm
km91 wrote: Thu Mar 28, 2024 3:52 pm

The real yield comes from the discount to par, 0.8919, only. The inflation adjusted principal does not affect the real yield

The price you paid includes the real yield component, the discount to par, and the inflation accrual, a premium to par

At maturity you will receive $64k par indexed to 2021 dollars, in 2024 you paid for $64k par indexed to 2021 dollars (64,000 x 1.1873). Therefore at maturity you will have $64k real in 2024 dollars
If inflation is 0% between now and 2031, I am going to receive $75k at maturity. Correct?
Yes, but only $64k is real par. The other $11k is the inflation adjustment that you paid for in the purchase price as a premium above par (64,000 x (1.1873 - 1)). You paid $11k for accrued inflation upfront and recover it on the back end

Imagine this. I bought this bond as a new issue at auction in 2021 for $64k. If held to maturity I will have maintained $64k in real purchasing power. In Jan 2024 I sell it to you at a price of 0.8919 and an inflation index of 1.1873, for $67k total. You immediately sell it back to me at the same terms and price. I am no better or worse off than before I sold you the bond, but now if held to maturity I have $75k of real purchasing power. How?
Loukycpa doesn't care about measuring in 2021 dollars. His baseline is 2024. He will earn about 1.8% real from here. Part of that return is the puny coupon of 0.125%. The remainder is real yield which will increase the purchasing power of his investment by a factor of 1/0.8919 or 12%. He will indeed have $75K of purchasing power measured in 2024 dollars.

km91 got hosed by selling this bond for only 0.8919. His real yield was negative. You say it was sold for $67k, but that is $67k in 2024 dollars. it was sold for 0.8919 x $64k or $57k in 2021 dollars. km91's loss is loukycpa's gain.
Agree from an investment point of view buying this bond in 2024 I don't care about measuring in 2021 dollars, except in the mechanical sense of understanding the pricing.

As far as whether the seller of the bond is getting hosed, I would say it depends and time will tell. If the seller invests the money and earns more than 2% real between now and 2031 on the money, I suppose they are better off.
The seller of the bond might have bought it at the originating auction, in which case his price was 111.669997, ignoring the inflation adjustment. (auction price found here: https://eyebonds.info/tips/hist/tips81hista.html ). He sold it 3 years later for 89.19. His loss in real terms is 1-89.19/111.669997 or 20.3%. Actually, it was a bit less since he did collect the 0.125%/year coupons along the way. That is pretty bad for "safe" fixed income in my book. If it was held in a taxable account, he had to pay ordinary income tax rates on the coupons and the OID every year. (OID amounts are listed at the above link.)

I thought I should point that out to highlight the risk of having to sell a long duration bond well before maturity.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

Svensk Anga wrote: Fri Mar 29, 2024 11:28 am The seller of the bond might have bought it at the originating auction, in which case his price was 111.669997, ignoring the inflation adjustment. (auction price found here: https://eyebonds.info/tips/hist/tips81hista.html ). He sold it 3 years later for 89.19. His loss in real terms is 1-89.19/111.669997 or 20.3%. Actually, it was a bit less since he did collect the 0.125%/year coupons along the way. That is pretty bad for "safe" fixed income in my book. If it was held in a taxable account, he had to pay ordinary income tax rates on the coupons and the OID every year. (OID amounts are listed at the above link.)

I thought I should point that out to highlight the risk of having to sell a long duration bond well before maturity.
Right. "Safe" in investment terms means low uncertainty of the return for the holding period. If the holding period is from purchase date to maturity, then the uncertainty of the return is indeed low; i.e., the investment is very safe.

Selling before maturity eliminates the certainty you get by holding to maturity.

Note that "safe" does not mean you earn a positive return. The yield on this TIPS at auction was -0.987%, so although the internal rate of return is certain if held to maturity, the buyer was guaranteed to lose almost 1% per year in real terms, which is what you get if you buy at 111.67 and it matures at 100.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by protagonist »

Questions for Kevin:

As recently as mid-December 2023, if I recall correctly, the vast majority of your TIPS portfolio were short term (2024-2027??), and your plan was to use your excess maturing 1/24s to buy 2028-2029s.
Within a matter of a few weeks (at best), if I am correct (I am going on memory, so correct me if I am wrong), you seemed to shift that strategy to selling 2024s and buying 2034s and 204xs to lock in current rates and to cover the gap years.
Now you are prematurely selling your later maturing 2024s for the same purpose.

My questions:
1. What made you suddenly change your strategy?
2. What will you be doing over the course of the next year , once you have sold all your excess 2024s? If rates remain favorable, will you move on to selling your excess 2025-2027s this year to buy more 2034s and 2040s for the gap years? How and when do you plan to fill out the years 2028-2032/3?
3. If you intend to sell 2025-2027s within the next year or so to buy longer term TIPS, in what order will you give priority to selling, and why?
4. When 7/34s become available, will you give priority to funding them with 1/34s (and a few 2040s), or with more of your short term TIPS?
5. If you own TIPS in both taxable and tax-deferred accounts, would you give priority to selling the short TIPS to trade for long TIPS in tax-deferred, assuming large coupon payments are not very important to you?

You and I are of similar age, and we started focusing on TIPS around the same time, though our ladders to date are quite different and our objectives, I think, are also a bit different. I think I also have a larger proportion of TIPS in taxable than you do because I maxed out TIPS in my IRA. I believe I am more interested in liability-matching than you, though due to recent life changes, knowing my future needs is difficult. I think I have considerably more invested in TIPS per year over a ten year ladder than I anticipate needing for each year's expenses (probably at least twice as much).

I respect you as an expert when it comes to these matters, so I am interested in your thought process and how it is shifting. I, too, am in the process of possibly making some revisions in my plan.
paper200
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by paper200 »

This is how the bond may play out assuming a 2.1% average inflation. I had set up the the calculation in excel based on Cruncher & Kevin et. al.

Individual Note/Bond calculation of return Bond Price
CUSIP 91282CBF7 Years 6.87
Face value 64000.00 Periods 13.75
Shares 64 PV-A $514.97
Settlement 3/4/2024 PV $56,558.53
Matures 1/15/2031 Value $57,073.50
Price $89.18
Coupon 0.125%
Ref. CPI at Issue 260.31619
CPI at buy 306.90771
Index Ratio at Buy 1.17898
Buy Price $89.19
Principal Cost $67,298.09
Principal Amt $75,454.75
YTM 1.80630%


Inflation expection 1.05% for 1/2 year
Prev Coupon Date 1/15/2024
Next Coupon Date 7/15/2024
Days in Period 182
Days before settle 49
Accrued Int $12.70 Nominal XIRR 3.97%
YTM 1.81%
Total Received $76,115 $88,051

Days after settle 133 133
# of full periods 13 13
Avg days.period 182.66 182.66
Inflation Factor 1.178980493
Date_R Cash Flow_1, Zero Inflation since buy IF Expectation or Actual index Cash Flow_2 with IF/ Actual CPI
3/4/2024 -$67,311 1.17898 -$67,311
7/15/2024 $47.16 1.19136 $47.65
1/15/2025 $47.16 1.20387 $48.15
7/15/2025 $47.16 1.21651 $48.66
1/15/2026 $47.16 1.22928 $49.17
7/15/2026 $47.16 1.24219 $49.69
1/15/2027 $47.16 1.25523 $50.21
7/15/2027 $47.16 1.26841 $50.74
1/15/2028 $47.16 1.28173 $51.27
7/15/2028 $47.16 1.29519 $51.81
1/15/2029 $47.16 1.30879 $52.35
7/15/2029 $47.16 1.32253 $52.90
1/15/2030 $47.16 1.33642 $53.46
7/15/2030 $47.16 1.35045 $54.02
1/15/2031 $75,501.91 1.36463 $87,390.94
Having freedom, food and roof is being 90% lucky in life and so is index investing. So, don't let the remaining 10% bother you.
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Kevin M
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

protagonist wrote: Fri Mar 29, 2024 2:07 pm Questions for Kevin:

As recently as mid-December 2023, if I recall correctly, the vast majority of your TIPS portfolio were short term (2024-2027??), and your plan was to use your excess maturing 1/24s to buy 2028-2029s.
Within a matter of a few weeks (at best), if I am correct (I am going on memory, so correct me if I am wrong), you seemed to shift that strategy to selling 2024s and buying 2034s and 204xs to lock in current rates and to cover the gap years.
Don't remember exactly what my plan was, but I can tell you what I actually did.

Your first observation is correct. In 2022 I bought only short-term TIPS, mostly 2023-2024s. The high inflation spooked me, and I wanted some inflation hedging even at negative yields, but I didn't want to go long at negative yields. I bought a few 2024-2027s in mid-2022 just to get a small positive yield. I started extending maturity slightly to 2025-2027 in 2023. This was mostly at Fido, but a little at Vanguard. My last Fido TIPS purchase was a Jan 2027 at the beginning of August, after which I transferred everything to Schwab for better Treasury pricing and the transfer bonus. I have bought all of my TIPS in IRAs.

In September 2023 I bought my first TIPS in my Schwab IRA, some Jul and Oct 2027s. I bought a small lot of Jan 2028s in Oct. By this time my IRA was almost all TIPS.

In late December 2023 I sold some Jan 2024s and bought some 2040s with the proceeds. Then I swapped some Jan 2024s for 2047s, then continued this until January 8, 2024 buying more 2040-2047s (sold the last of my Jan 2024s on Jan 8). I had an IRA CD mature and transferred proceeds to Schwab and bought more 204Xs with it on Jan 12. I remember posting at the time that I was increasing my average duration to reduce reinvestment risk. Remember my postings about a barbell approach?

On Jan 23 I sold my first lot of Apr 2024s, and bought 2040s with the proceeds. I continued swapping Apr 2024s for 204Xs. On Feb 2 I bought my first lot of 2034s with proceeds from a lot of Apr 2024s. It was about then that I decided to build an actual TIPS ladder with rungs maturing every year until 2047, using a Desired Annual Real Amount (DARA) that was about equal to my current residual annual expenses. So I continued selling Apr 2024s and buying what I needed for the ladder. I sold the last of my Apr 2024s on 02/26/2024.

On Feb 27 I started selling my Jul 2024s to continuing filling out the rungs of the ladder. On March 25 I sold the last of my Jul 2024s and bought some 2040s with the proceeds. I've bought only 2034s and 2040s since March 13, having filled out the rest of the rungs.

I was debating whether or not to sell Oct 2024s or some 2027s to complete the ladder. The seasonally-adjusted yield of the Oct 2024s is higher, but they don't serve much purpose in the TIPS ladder, so yesterday I sold my first lot of Oct 2024s and bought some 2040s with the proceeds.

As of now my ladder is 94% complete, calculated as the cost of bonds required divided by the cost of bonds already held, based on yesterday's prices. I have 92% of the 2040s I need, and 80% of the 2034s. I've been favoring the 2040s lately due to the 2+% yields, while the 2034s were about 1.9% when I last pulled quotes yesterday.
protagonist wrote: Fri Mar 29, 2024 2:07 pmNow you are prematurely selling your later maturing 2024s for the same purpose.
My questions:
1. What made you suddenly change your strategy?
Not sure it was sudden, but this thread helped convince me that 2% was an attractive long-term yield, so I worked on breaking my emotional reluctance to go long term with bonds. Then at some point I just decided that building a ladder made sense. I think part of it was providing some discipline to just get me to keep buying longer-maturity TIPS, but accepting lower yields for the 202Xs and 203Xs than for the 204Xs due to the inverted yield curve.
2. What will you be doing over the course of the next year , once you have sold all your excess 2024s? If rates remain favorable, will you move on to selling your excess 2025-2027s this year to buy more 2034s and 2040s for the gap years? How and when do you plan to fill out the years 2028-2032/3?
Once I buy the rest of the 2034s and 2040s I need for the gap years in the ladder, I'll pause and see what happens with yields. I'll still have way more in the shorter-maturity TIPS than I need, so these essentially are part of my risk portfolio, due to the reinvestment risk. The average duration of my TIPS is only 5.6 years, so much shorter than the 11-12 or so it would be for a fully built out 23-year ladder.

If long-term yields look attractive enough based on my gestalt at the time, I'll start using RMD-based estimated annual real amounts to continue to add to the longer rungs of the ladder. I discuss the RMD approach in this thread: Building a TIPS ladder for IRA RMDs - Bogleheads.org
3. If you intend to sell 2025-2027s within the next year or so to buy longer term TIPS, in what order will you give priority to selling, and why?
At this point I think I'd lean toward selling whatever 2025s I didn't need for my first RMD, which I'll take that year. The shorter the term, the less unexpected inflation protection provided. The inverted yield curve makes it emotionally more difficult to sell higher yielding bonds, but the yield curve is signaling falling yields, and based purely on expectations theory, rolling shorter-term bonds has the same expected return as holding longer-term bonds. In theory there's a term premium for going longer, but that term premium has been negative at times in recent years, and it's hard to say what the term premium really is.
4. When 7/34s become available, will you give priority to funding them with 1/34s (and a few 2040s), or with more of your short term TIPS?
I haven't thought about Jul 2034s yet. If I bought them, it probably would be mostly with proceeds from selling Jan 2034s, but perhaps a small amount of 2040s if required to match the duration of the Jul 2034. At least that's what I'd do if I didn't have a large excess of shorter-term TIPS. Maybe instead I'd sell some Oct 2024s if there are any left, or Jan 2025s if not, and work toward the RMD thing.
5. If you own TIPS in both taxable and tax-deferred accounts, would you give priority to selling the short TIPS to trade for long TIPS in tax-deferred, assuming large coupon payments are not very important to you?
I only hold TIPS in my IRA now, so haven't thought about this at all.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by protagonist »

Kevin:
Excellent (and interesting) response.
Thanks for taking al that time.
Contrary to what one might assume by my continuing presence in this forum, I am not much of a "finance guy". I never studied it, and it is not even particularly a big interest of mine. I do, however, believe that it is important to know what one needs to know to manage important aspects of one's life (such as the nest egg one worked their entire life to build), and not blindly delegate those responsibilities to others, especially in a field where the so-called "experts" are often like the Emperor in the story "The Emperor's New Clothes".
So I try to learn just what is absolutely necessary to make intelligent financial decisions, and ignore the rest. I frequent this forum because it has been a great source for the info. that I need, lots of intelligent and knowledgeable people lurk here, and because I also like to give back by sharing what I learned (or what I just know from my 71 years on this blue marble) with others.
But I don't pretend to be an "expert" (I was especially ignorant regarding bonds- I had been "bond-averse" for a long time due to the record low interest rates, so learning much about them did not fit my "need to know" strategy). Now I need to learn about them.

I have learned a lot from you, Kevin. Thank you for that.

Kevin M wrote: Fri Mar 29, 2024 5:12 pm
The high inflation spooked me.... I bought a few 2024-2027s in mid-2022 just to get a small positive yield.
That is exactly what I did. Almost all of my fixed income was in CDs and low yielding I-bonds at the time. The CDs were all due to mature starting in mid-2022 through 2023 and my plan (which I stuck to) was to use the proceeds (as well as that from I-bonds when high variable rate was no longer available) to buy TIPS.. In mid-2022 my first big CD matured and I invested the proceeds in all 2023-2027s at low yields, not knowing in what direction inflation was headed. That amounted to about 15-20% of my total fixed income portfolio.

Where my plan veered from yours is that as the other funds gradually became available (and it looked like inflation would be controlled and yields on TIPS rose), I then focused on maturities between 2028-2033, also further padding years 2024-2027 with better yielding TIPS. I also slightly overweighted the later years to lock in the high yields. My guess is that I have much more invested in each rung than I will need for spending....my plan was to use the excess to fill the gap years when they became available.

Now I am thinking about taking your lead and selling some of my earlier maturities to overweight 2034 so I can lock in today's yields to fund the gap years. I did buy a few 2040-2042s (10 of each) when yields were near their peak, but I am still reticent to buy more, since I don't know my chances of living that long. I understand the advantage of doing what you and others are doing, using both 2040s and 2034s to fund the gap years vs. just using 2034s and rolling excess forward as the gap year bonds become available....I just don't know if that advantage is significant enough to make much difference (since I will be 88 in 2040).
I remember posting at the time that I was increasing my average duration to reduce reinvestment risk. Remember my postings about a barbell approach?
Yes.
I am still confused about the best approach, concerning how to fund the longer maturity TIPS. Almost all of my fixed income investments are in TIPS now, but only about 55% of them are in tax-deferred (IRA) because I maxed out that space.

So my current dilemmas are:
- Should I prioritize selling those in my IRA for the purpose of tax efficiency? Or should I prioritize those with high coupon rates in taxable?
- Should I bother buying 2040s given my advancing age?
- Should I first sell excess 2033s, then maybe 2032s and 2031s to buy more 2034s (+/- 2040s)? Or should I first sell 2024s, then 2025s, then 2026s?
- You made a comment about maybe selling your 2027s , I assumed before your 2025s or 2026s. I don't understand why you would single out 2027s:
I was debating whether or not to sell Oct 2024s or some 2027s to complete the ladder.
You also stated:
the yield curve is signaling falling yields
Looking back over the past 1.5-2 years (when I started looking), the TIPS yields have risen and fallen, at times what seemed unpredictably (by me, anyway). Do you think yields are near their peak now, and why? I get that an inverted yield curve might suggest that investors believe that, and I have falsely believed that before when yields started dropping like they just started doing again, but does that mean much?

I suppose I am overthinking a lot of this, since whatever decisions I make probably won't have a significant enough impact on my lifestyle to matter, and I probably should do more to translate that into practice and spend less time thinking about this. I (humbly) think many of us who frequent this forum have a similar problem. Bogleheads should have an "Overanalyzers Anonymous" chapter. "Hello. I am Protagonist and I am an overanalyzer ." :sharebeer

Anyway, thanks again for your indulgence,
Protag.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

protagonist wrote: Sat Mar 30, 2024 10:53 am Now I am thinking about taking your lead and selling some of my earlier maturities to overweight 2034 so I can lock in today's yields to fund the gap years. I did buy a few 2040-2042s (10 of each) when yields were near their peak, but I am still reticent to buy more, since I don't know my chances of living that long. I understand the advantage of doing what you and others are doing, using both 2040s and 2034s to fund the gap years vs. just using 2034s and rolling excess forward as the gap year bonds become available....I just don't know if that advantage is significant enough to make much difference (since I will be 88 in 2040).
Yeah, we are the same age, and I also don't know if I'll be alive when my long TIPS mature; I would be almost 95 if still alive when my 2047s mature. My dad died at 82, but my mom is 93 and still walks a mile a day, even with some pretty bad heart disease and other health issues. Quite honestly, given the aches and pains I already have, I'm not sure I'll want to live into my 90s. My mom is in pain all the time, but still manages a cheerful outlook, and says she still enjoys being alive.

So if I outlive my TIPS, the ones that are left will go to my heirs. I don't see how that's any worse than them inheriting the stocks and other fixed income in my portfolio. So I get the longevity insurance, but they get what's left if I don't need it.
protagonist wrote: Sat Mar 30, 2024 10:53 amI am still confused about the best approach, concerning how to fund the longer maturity TIPS. Almost all of my fixed income investments are in TIPS now, but only about 55% of them are in tax-deferred (IRA) because I maxed out that space.

So my current dilemmas are:
- Should I prioritize selling those in my IRA for the purpose of tax efficiency? Or should I prioritize those with high coupon rates in taxable?
I haven't thought a lot about this, but I think I'd lean toward making the decision based on other criteria, like maturity or yields.

I will say that I tend to disagree with the post you quoted about TLH not making any sense for TIPS. That seemed to be more of an argument against TLH in general. It's true that with TLH you are deferring the tax, not eliminating it, but to the extent you use the $3K/year tax loss against your other income, you are no worse off then if you don't TLH, and maybe slightly better if TLH in general makes sense.
- Should I bother buying 2040s given my advancing age?
If you use 2040s only in conjunction with 2034s to fund the gap years, you will have disposed of them by Jan 2029. I already shared my view on holding more 204Xs than that above.
- Should I first sell excess 2033s, then maybe 2032s and 2031s to buy more 2034s (+/- 2040s)? Or should I first sell 2024s, then 2025s, then 2026s?
- You made a comment about maybe selling your 2027s , I assumed before your 2025s or 2026s. I don't understand why you would single out 2027s:
Given that I decided to sell Oct 2024s before 2027s, my view on this should be clear, at least with respect to the 2024s.

The reason I considered selling the 2027s is that they have the lowest seasonally-adjusted yield of all TIPS with maturities less than or equal to that, due to the inverted yield curve at the short end:

Image

And of course I have an excess of them, unlike 2028 and beyond that have even lower yields. As I said, I decided to sell Oct 2024s instead, but I could change my mind next week, although I kind of doubt I will.
protagonist wrote: Sat Mar 30, 2024 10:53 amYou also stated:
the yield curve is signaling falling yields
Looking back over the past 1.5-2 years (when I started looking), the TIPS yields have risen and fallen, at times what seemed unpredictably (by me, anyway). Do you think yields are near their peak now, and why?
I have no idea.

All I know is that institutional bond traders must think that short-term yields will decline relative to longer-term yields. Otherwise they'd be piling into shorter-term TIPS, driving the prices up and the yields down. So excluding any term-premium, which could be positive or negative, rolling 1-year TIPS for 10 years has the same expected return as holding a 10-year TIPS to maturity.

I think I would experience more regret if 2034/2040 yields are 1% when my Oct 2024s mature, than if they are 3%, and I am selling Oct 2024s now to buy them at 1.9-2.0% now. If they are 3%, I'll sell more shorter-term TIPS to buy even more of the longer term TIPS at the higher yields.
I get that an inverted yield curve might suggest that investors believe that, and I have falsely believed that before when yields started dropping like they just started doing again, but does that mean much?
Right. No one is good at predicting interest rates, including the institutional bond traders that are determining the yield curve. The yield curve tells us something about expectations, but it doesn't guarantee that the future will match those expectations.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by protagonist »

Thanks again, Kevin! One more question.
Kevin M wrote: Sat Mar 30, 2024 1:16 pm
excluding any term-premium, which could be positive or negative, rolling 1-year TIPS for 10 years has the same expected return as holding a 10-year TIPS to maturity.

I get that now. Except...
What do you mean by "term premium"? Is that synonymous with the discount/premium at which you purchased the bond, or something else?
And does it influence which ones you sell? And if so, how and why?
(That was more than one question. Sorry.)
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Kevin M
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

protagonist wrote: Sat Mar 30, 2024 6:06 pm Thanks again, Kevin! One more question.
Kevin M wrote: Sat Mar 30, 2024 1:16 pm excluding any term-premium, which could be positive or negative, rolling 1-year TIPS for 10 years has the same expected return as holding a 10-year TIPS to maturity.
I get that now. Except...
What do you mean by "term premium"? Is that synonymous with the discount/premium at which you purchased the bond, or something else?
And does it influence which ones you sell? And if so, how and why?
(That was more than one question. Sorry.)
The New York Fed has a web page related to this: Treasury Term Premia. From that page:
In standard economic theory, yields on Treasury securities are composed of two components: expectations of the future path of short-term Treasury yields and the Treasury term premium. The term premium is defined as the compensation that investors require for bearing the risk that interest rates may change over the life of the bond. Since the term premium is not directly observable, it must be estimated, most often from financial and macroeconomic variables.
The first part, "expectations of the future path of short-term Treasury yields" means that, other than the term premium, the expected return of a 10-year Treasury is the same as that of rolling a 1-year (or 1m or 3m or 6m) Treasury for 10 years. With the current inverted yield curve, this means that the shorter-term yields are expected to decline.

For example, on Thursday the 1y CMT yield was 5.03% and the 10y was 4.20%, so over the next 10 years the 1y yield is expected to decline so that you'd end up earning an annualized 4.20% if you rolled the 1y annually for 10 years.

The term premium is the extra yield, above what the expectations part implies, that is compensation for taking the risk of going long, given that the path of short-term yields is uncertain.

Next on the page:
Current and former New York Fed economists Tobias Adrian, Richard K. Crump, and Emanuel Moench developed a statistical model to describe the joint evolution of Treasury yields and term premia across time and maturities, described in detail in Adrian, Crump, and Moench (2013).
Here's the term premium chart that's linked on that page:

Image

Note that the term premium usually is positive, which is what we'd expect, since investors should be compensated for the risk of the uncertainty of forward short-term rates, but it has been negative at times in recent years, and the most recent value, for Feb 2024, is -0.162 (negative).

What is the implication of a negative term premium? It seems to indicate that investors view shorter-term Treasuries as riskier than longer-term Treasuries. One way to look at that might be that reinvestment risk is getting more weight in investment decisions than price risk. Ben Bernanke wrote an article about this in 2015: Why are interest rates so low, part 4: Term premiums | Brookings.

The economic conditions were different when he wrote the article, so some of the ideas don't apply to the current environment, but he did say this:
If longer-term bonds are a hedge against risk, then investors should be willing to accept low or even negative compensation for holding bonds rather than short-term securities.
At any rate, like the liquidity and unexpected inflation premia that apply to breakeven inflation, the term premium is not observable, so the best we can do is use models to estimate it. That's why I expressed uncertainty as to what term premium is embedded in the present yield curve.

In terms of the investment decisions we've been discussing, I brought it up in pondering whether to sell shorter-term TIPS with higher yields, or not quite as short-term TIPS with lower yields to buy longer-term TIPS with even lower yields.

If we assume that the term premium is 0, then the expected return of rolling a 1y TIPS into another 1y TIPS has the same expected return as holding a 2y TIPS; i.e., the 1y yield 1y from now is expected to be lower by an amount that can be determined from this equation:

(1+y1) * (1+y1_1) = (1+y2)^2,

where y1 = 1y yield now, y1_1 = 1y yield one year from now, and y2 = 2y yield. We can solve for y1_1 as follows:

y1_1 = (1+y2)^2/(1+y1) - 1

Plugging in the 1y and 2y CMT yields from Thursdsay:

y1_1 = (1+4.59%)^2/(1+5.03%)-1 = 4.15%

Which means that with a term premium of 0, the expected 1y yield one year from now is 4.15%.

So if the term premium is 0, I should be indifferent to rolling a 1y bond for two years or holding a 2y bond to maturity. If I were to sell my 2y TIPS to buy longer-term TIPS, I am expressing a preference for holding some shorter-term TIPS, which implies I would roll the 1y TIPS into another 1y TIPS at maturity. Rather than do that, I might as well just sell the 1y TIPS, even though the yield is higher, especially since it is functioning more like a nominal bond than the 2y TIPS.

Since the term premium is not observable, and it might even be slightly negative now, I just assume it's zero.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by protagonist »

Thanks for the explanation of term premiums, Kevin.

To some extent, would it be correct to say that "term premium" is less relevant to TIPS investors than to investors in nominal bonds, since inflation risk is taken off the table? There is still the "reinvestment risk" component, I get that...and investors today must be thinking that yields will likely decline in future years...but at least TIPS investors don't have to worry about what happened to people who held nominal bonds when inflation peaked in 2022.

I am not as worried about future yields declining as some might be, who are more focused in making as much profit as possible out of their fixed income investments. For that reason, bid/ask spreads and seasonality seem (at least in today's market) pretty insignificant to me. My rationale for fixed income investing, by far, is keeping up with inflation. Of course, I would rather make 3% real than zero real....who wouldn't?....but zero real would still (almost, factoring in taxes) meet my objective. My reason for "going long" is, to some extent, to lock in today's favorable yields, but probably more to assure that in the future I won't be stuck with, say, 3% nominal yielding bonds or CDs if inflation goes double digit (like it almost did in 2022, when most of my, and your, fixed income money was in 3-4% CDs) . My reason to balance that with shorter TIPS with more reinvestment risk is that I don't know when I will die.

My only real objective is to be free from financial worry....not to get richer. If I get richer, great....but if not, I will not lose any sleep.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by billaster »

protagonist wrote: Mon Apr 01, 2024 9:00 am To some extent, would it be correct to say that "term premium" is less relevant to TIPS investors than to investors in nominal bonds, since inflation risk is taken off the table? There is still the "reinvestment risk" component, I get that...and investors today must be thinking that yields will likely decline in future years...but at least TIPS investors don't have to worry about what happened to people who held nominal bonds when inflation peaked in 2022.
Term premium and inflation premium are separate risks. As their name implies, one involves time and the other involves inflation.

The inflation premium is determined by comparing inflation adjusted and nominal bonds keeping the term risk fixed. That is comparing 5-year nominals to 5-year TIPS and 10-year nominals to 10-year TIPS.

Likewise the term premium is determined by comparing short and long term bonds while keeping the inflation risk fixed. So you compare 5-year nominals to 10-year nominals and 5-year TIPS to 10-year TIPS.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by MtnBiker »

protagonist wrote: Fri Mar 29, 2024 2:07 pm

You and I are of similar age, and we started focusing on TIPS around the same time, though our ladders to date are quite different and our objectives, I think, are also a bit different.
protagonist wrote: Sat Mar 30, 2024 10:53 am
- Should I bother buying 2040s given my advancing age?
I know you are trying to have a conversation with Kevin, but I thought it might help to give another slightly different perspective on ladder holdings at advancing ages. I am 71, about the same age as you and Kevin.

Kevin has stated that he is constructing a ladder with rungs maturing every 6 months. Most people seem to have annual rungs. My ladder has rungs maturing once every 2 years, which is less ideal for providing steady income replacement. But to me, having fewer rungs/holdings just seems simpler to manage, while providing reasonably good protection against long-term unexpected inflation. I don't know exactly how much income I will need or exactly when it will be needed. But knowing there will be an income stream lets me sleep at night. I know that if I need to sell a portion of a rung up to a year prior to maturity, there isn't much penalty for doing so. And if I need to hold some income for an additional year or two after maturity, there are various short-term investments where I could park the money. I have been following this path for the last 6 years and see no reason to change.

Kevin has TIPS out to 2047. The last rung in my ladder is 2036, when I will be age 84. The 2036 rung currently consists of a 50/50 mix of some excess 2032s and some 2040s (with average maturity equal to 2036). The 2040s that I am holding will be sold, together with the excess 2032s, in 2026 to buy the 2036s. I have no intension of holding any 2040s to maturity. My 2040s are just placeholders that are approximately duration matched for the last remaining gap year in my ladder.

If I live to anywhere near age 84-85, I will then have some idea of whether I might need additional income beyond that point. If needed, I plan to buy longevity insurance in the form of immediate annuities at around age 85. My understanding is that the average duration of an annuity purchased at age 85 is about 5 years. Thus, the price of such an annuity is expected to rise or fall with changes in interest rates approximately in concert with the price of TIPS maturing in 5 years, at age 90, in 2042. So, my funds intended for annuity purchases are inflation protected and duration matched to minimize reinvestment risk by investing in 2042 TIPS. There is enough in that bucket to provide annuity income approximately replacing the income from the ladder. If I never need the annuities, the special needs trust for my disabled son will be that much larger. I recognize that the ongoing annuity income beyond age 85 would not be inflation protected. But there is also a risk portfolio (now primarily invested in equities) to draw upon if the base annuity income is not enough.

I'm not saying there is anything wrong with Kevin's approach. There are different paths to achieving liability matching. Pick the path that makes sense to you.  
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by watchnerd »

MtnBiker wrote: Mon Apr 01, 2024 10:22 pm
Kevin has stated that he is constructing a ladder with rungs maturing every 6 months. Most people seem to have annual rungs.
Do most people really have annual rungs?

I have 6 month rungs, like Kevin.

The maturity dates/auction dates occur every 6 months, so it seems natural.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by IDpilot »

watchnerd wrote: Mon Apr 01, 2024 10:49 pm
MtnBiker wrote: Mon Apr 01, 2024 10:22 pm
Kevin has stated that he is constructing a ladder with rungs maturing every 6 months. Most people seem to have annual rungs.
Do most people really have annual rungs?

I have 6 month rungs, like Kevin.

The maturity dates/auction dates occur every 6 months, so it seems natural.
My rungs are annual since that means I have half the stuff to track as I would for every six months!
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Svensk Anga »

watchnerd wrote: Mon Apr 01, 2024 10:49 pm
MtnBiker wrote: Mon Apr 01, 2024 10:22 pm
Kevin has stated that he is constructing a ladder with rungs maturing every 6 months. Most people seem to have annual rungs.
Do most people really have annual rungs?

I have 6 month rungs, like Kevin.

The maturity dates/auction dates occur every 6 months, so it seems natural.
6 months works for 10-year TIPS but if you need the 30-year variety, those are available maturing only once per year, in February.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

MtnBiker wrote: Mon Apr 01, 2024 10:22 pm Kevin has stated that he is constructing a ladder with rungs maturing every 6 months.
I actually have TIPS maturing at every maturity date through Oct 2027, so Jan, Apr, Jul and Oct of each year. When I started buying the shorter-term TIPS, I wanted to be able to roll them as frequently as possible, still being very much in the short-term way of thinking, and hoping that yields would continue to increase, which they pretty much did for awhile.

When I got serious about the ladder I decided on Jan and Jul for 2028-2033. No deep thinking involved--I just still liked the idea of having some mature more often than once per year, but for whatever reason, decided to skip Apr and Oct for 2028 and 2029--maybe because there are only Jan and Jul maturities for 2030,31 and 33 (there are Apr for 2032).

As mentioned, there are only Feb maturities for 2040 and beyond, so it's annual rungs for 2040-2047, but of course lots of the 2040s are to cover the gap years.

As a quick aside, TIPS yields have increased nicely the last two days. The Jan 2034 is back above 2%; I snagged some at 2.02% or so today. I sold some Oct 2027s yesterday and today for my 2034 purchases, since I decided I have way more 2027s than I need (many more than I have Oct 2024s).
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

protagonist wrote: Mon Apr 01, 2024 9:00 am Thanks for the explanation of term premiums, Kevin.

To some extent, would it be correct to say that "term premium" is less relevant to TIPS investors than to investors in nominal bonds, since inflation risk is taken off the table?
Not according to standard economic theory. Here's a link to another good paper that discusses TIPS, breakeven inflation, term premia, etc.: The Fed - Tips from TIPS: Update and Discussions. From that paper:
By standard economic theory, nominal and real yields can be decomposed as:

nominal yield = real yield + expected inflation + inflation risk premium; (1)

real yield = expected average future real short rate + real term premium, (2)

where the inflation risk premium and the real term premium are extra compensations bond investors demand for bearing inflation risks and real interest rate risks, respectively.
We can combine equations 1 and 2 to write:

nominal yield = expected average future real short rate + real term premium + expected inflation + inflation risk premium

So we see that a nominal yield includes both a real term premium and an inflation risk premium. We certainly could combine these two and just call it a nominal term premium. We could also combine expected average future real short rate and expected inflation and call it expected average future nominal short rate. So:

expected average future nominal short rate = expected average future real short rate + expected inflation
nominal term premium = real term premium + inflation risk premium

Then we could write:

nominal yield = expected average future nominal short rate + nominal term premium.

It seems that this has been done implicitly in the quote from the first page I linked:
In standard economic theory, yields on Treasury securities are composed of two components: expectations of the future path of short-term Treasury yields and the Treasury term premium.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

I seem to recall that 2.25% was a trigger for someone for buying long-term TIPS. Right now I see this at Schwab:

Image

So the 2047 is at 2.25%, and at Schwab it's for min qty 1.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by protagonist »

MtnBiker wrote: Mon Apr 01, 2024 10:22 pm
protagonist wrote: Fri Mar 29, 2024 2:07 pm

You and I are of similar age, and we started focusing on TIPS around the same time, though our ladders to date are quite different and our objectives, I think, are also a bit different.
protagonist wrote: Sat Mar 30, 2024 10:53 am
- Should I bother buying 2040s given my advancing age?
I know you are trying to have a conversation with Kevin, but I thought it might help to give another slightly different perspective on ladder holdings at advancing ages. I am 71, about the same age as you and Kevin.

Kevin has stated that he is constructing a ladder with rungs maturing every 6 months. Most people seem to have annual rungs. My ladder has rungs maturing once every 2 years, which is less ideal for providing steady income replacement. But to me, having fewer rungs/holdings just seems simpler to manage, while providing reasonably good protection against long-term unexpected inflation. I don't know exactly how much income I will need or exactly when it will be needed. But knowing there will be an income stream lets me sleep at night. I know that if I need to sell a portion of a rung up to a year prior to maturity, there isn't much penalty for doing so. And if I need to hold some income for an additional year or two after maturity, there are various short-term investments where I could park the money. I have been following this path for the last 6 years and see no reason to change.

Kevin has TIPS out to 2047. The last rung in my ladder is 2036, when I will be age 84. The 2036 rung currently consists of a 50/50 mix of some excess 2032s and some 2040s (with average maturity equal to 2036). The 2040s that I am holding will be sold, together with the excess 2032s, in 2026 to buy the 2036s. I have no intension of holding any 2040s to maturity. My 2040s are just placeholders that are approximately duration matched for the last remaining gap year in my ladder.

If I live to anywhere near age 84-85, I will then have some idea of whether I might need additional income beyond that point. If needed, I plan to buy longevity insurance in the form of immediate annuities at around age 85. My understanding is that the average duration of an annuity purchased at age 85 is about 5 years. Thus, the price of such an annuity is expected to rise or fall with changes in interest rates approximately in concert with the price of TIPS maturing in 5 years, at age 90, in 2042. So, my funds intended for annuity purchases are inflation protected and duration matched to minimize reinvestment risk by investing in 2042 TIPS. There is enough in that bucket to provide annuity income approximately replacing the income from the ladder. If I never need the annuities, the special needs trust for my disabled son will be that much larger. I recognize that the ongoing annuity income beyond age 85 would not be inflation protected. But there is also a risk portfolio (now primarily invested in equities) to draw upon if the base annuity income is not enough.

I'm not saying there is anything wrong with Kevin's approach. There are different paths to achieving liability matching. Pick the path that makes sense to you.  
That's interesting. Yes, everybody has a different approach. Thanks for sharing.

One question.... if you are only planning to buy TIPS out to 2036, instead of 2032s and 2040s, why not just buy 2034s now? I doubt if the yield you will get by splitting 2032s and 2040s would be very much different than just rolling 2034s into 2035s and then 2036s.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by bikechuck »

protagonist wrote: Mon Apr 01, 2024 9:00 am My only real objective is to be free from financial worry....not to get richer. If I get richer, great....but if not, I will not lose any sleep.
I heard someone use a baseball analogy the other day that as a 70 + year old retiree I agree with ... In retirement I am no longer looking to hit home runs, I am now trying to execute a series of bunt singles. I consider the rungs on my TIPS ladder to be a series of bunt singles.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Wrench »

bikechuck wrote: Tue Apr 02, 2024 12:17 pm
protagonist wrote: Mon Apr 01, 2024 9:00 am My only real objective is to be free from financial worry....not to get richer. If I get richer, great....but if not, I will not lose any sleep.
I heard someone use a baseball analogy the other day that as a 70 + year old retiree I agree with ... In retirement I am no longer looking to hit home runs, I am now trying to execute a series of bunt singles. I consider the rungs on my TIPS ladder to be a series of bunt singles.
Haha! I like that. I would add that it's also bunt singles for my spouse who will become my pinch hitter when I am no longer able to come to the plate.

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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by bpg1234 »

Kevin M wrote: Tue Apr 02, 2024 10:21 am As a quick aside, TIPS yields have increased nicely the last two days. The Jan 2034 is back above 2%; I snagged some at 2.02% or so today. I sold some Oct 2027s yesterday and today for my 2034 purchases, since I decided I have way more 2027s than I need (many more than I have Oct 2024s).
Kevin,
On the heels of you selling Oct 2027s and as a follow-on to my earlier post I'm looking for your additional perspective. I have 25 Jan 2030s and 25 July 2031s remaining to be filled in on my 10 year TIPS ladder. As options for doing this, I have 50 Oct 2027s as a second tranche in 2027 which is the only rung with 2 tranches so considering using these to roll over for completing the 2030 and 2031 rungs. However, I also have adequate funds available now in the brokerage MM account to use to fill in as well.

Curious if you think it would be more advantageous to roll over the existing Oct 2027s since less concern over what price I get since they may move up or down in somewhat similar fashion as long as yields are close?

Thanks in advance,
bpg1234
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by Kevin M »

bpg1234 wrote: Tue Apr 02, 2024 1:38 pm
Kevin M wrote: Tue Apr 02, 2024 10:21 am As a quick aside, TIPS yields have increased nicely the last two days. The Jan 2034 is back above 2%; I snagged some at 2.02% or so today. I sold some Oct 2027s yesterday and today for my 2034 purchases, since I decided I have way more 2027s than I need (many more than I have Oct 2024s).
Kevin,
On the heels of you selling Oct 2027s and as a follow-on to my earlier post I'm looking for your additional perspective. I have 25 Jan 2030s and 25 July 2031s remaining to be filled in on my 10 year TIPS ladder. As options for doing this, I have 50 Oct 2027s as a second tranche in 2027 which is the only rung with 2 tranches so considering using these to roll over for completing the 2030 and 2031 rungs. However, I also have adequate funds available now in the brokerage MM account to use to fill in as well.

Curious if you think it would be more advantageous to roll over the existing Oct 2027s since less concern over what price I get since they may move up or down in somewhat similar fashion as long as yields are close?

Thanks in advance,
bpg1234
If I had the cash and I didn't need it for anything else, I'd use it to buy the 2030s and 2031s. My money is where my mouth is, as I have no cash in the IRA in which I hold all of my TIPS. I had some nominal Treasuries there, but sold all of them not too long ago to buy TIPS.

Then, if the longer-term yields got even juicier, I might sell the extra 2027s at that point to add some more longer-term TIPS.

Buy why did you double up on the 2027s specifically? I have lots extra because they were the long end of my short-term TIPS buying spree.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by samulta52 »

Kevin M wrote: Tue Apr 02, 2024 11:37 am I seem to recall that 2.25% was a trigger for someone for buying long-term TIPS. Right now I see this at Schwab:

Image

So the 2047 is at 2.25%, and at Schwab it's for min qty 1.
I am making a ladder of years 2030-2038 before taking SS @70 yrs old. Does it make sense to pick some of these longer duration ones?
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by McQ »

Kevin M wrote: Tue Apr 02, 2024 11:37 am I seem to recall that 2.25% was a trigger for someone for buying long-term TIPS. Right now I see this at Schwab:

Image

So the 2047 is at 2.25%, and at Schwab it's for min qty 1.
That was me, reflecting at the end of the great rally off the October lows, which drove long TIPS yields down to 2.0%, and forced the current thread title.

Interestingly, today is the third time this year that 2040s yields have touched 2.25%. On the first pass I added $10,000, but only that amount, since I'm already 10% over my planned allotment. I held off on the second pass, waiting for more yield; same today.

To be clear, if I wasn't over my planned allotment, I would be buying at 2.25%. I'm not confident long TIPS yields will move much higher. But since I am over, I'm waiting for 2.30% now.

And although I do not expect to see 2.50% again ... never say never, and keep some powder dry.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by bpg1234 »

Kevin M wrote: Tue Apr 02, 2024 2:33 pm
bpg1234 wrote: Tue Apr 02, 2024 1:38 pm
Kevin M wrote: Tue Apr 02, 2024 10:21 am As a quick aside, TIPS yields have increased nicely the last two days. The Jan 2034 is back above 2%; I snagged some at 2.02% or so today. I sold some Oct 2027s yesterday and today for my 2034 purchases, since I decided I have way more 2027s than I need (many more than I have Oct 2024s).
Kevin,
On the heels of you selling Oct 2027s and as a follow-on to my earlier post I'm looking for your additional perspective. I have 25 Jan 2030s and 25 July 2031s remaining to be filled in on my 10 year TIPS ladder. As options for doing this, I have 50 Oct 2027s as a second tranche in 2027 which is the only rung with 2 tranches so considering using these to roll over for completing the 2030 and 2031 rungs. However, I also have adequate funds available now in the brokerage MM account to use to fill in as well.

Curious if you think it would be more advantageous to roll over the existing Oct 2027s since less concern over what price I get since they may move up or down in somewhat similar fashion as long as yields are close?

Thanks in advance,
bpg1234
If I had the cash and I didn't need it for anything else, I'd use it to buy the 2030s and 2031s. My money is where my mouth is, as I have no cash in the IRA in which I hold all of my TIPS. I had some nominal Treasuries there, but sold all of them not too long ago to buy TIPS.

Then, if the longer-term yields got even juicier, I might sell the extra 2027s at that point to add some more longer-term TIPS.

Buy why did you double up on the 2027s specifically? I have lots extra because they were the long end of my short-term TIPS buying spree.
Thanks Kevin as usual for your perspective. As for your question, initially was just sporadically buying TIPS in my TIRA for wealth preservation and for some reason at the time I had purchased two different tranches. When I then decided that a TIPS ladder would be beneficial I just filled in both.

Now though, after filling in the remaining 2030 and 2031 ladder rungs I will only have the 2029 rung remaining which I am going to fill in with the upcoming new 5 year April TIPS issuance although I will likely wait until after the auction and buy it on the secondary market.

I already have my allotment for 2034 but after reading more of your thoughts I just might consider what you outline and roll the October 2027 to additional 2034s which I can/will roll again once the 2035s become available.
Thanks again.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by MtnBiker »

protagonist wrote: Tue Apr 02, 2024 11:54 am
MtnBiker wrote: Mon Apr 01, 2024 10:22 pm
protagonist wrote: Fri Mar 29, 2024 2:07 pm

You and I are of similar age, and we started focusing on TIPS around the same time, though our ladders to date are quite different and our objectives, I think, are also a bit different.
protagonist wrote: Sat Mar 30, 2024 10:53 am
- Should I bother buying 2040s given my advancing age?
I know you are trying to have a conversation with Kevin, but I thought it might help to give another slightly different perspective on ladder holdings at advancing ages. I am 71, about the same age as you and Kevin.

Kevin has stated that he is constructing a ladder with rungs maturing every 6 months. Most people seem to have annual rungs. My ladder has rungs maturing once every 2 years, which is less ideal for providing steady income replacement. But to me, having fewer rungs/holdings just seems simpler to manage, while providing reasonably good protection against long-term unexpected inflation. I don't know exactly how much income I will need or exactly when it will be needed. But knowing there will be an income stream lets me sleep at night. I know that if I need to sell a portion of a rung up to a year prior to maturity, there isn't much penalty for doing so. And if I need to hold some income for an additional year or two after maturity, there are various short-term investments where I could park the money. I have been following this path for the last 6 years and see no reason to change.

Kevin has TIPS out to 2047. The last rung in my ladder is 2036, when I will be age 84. The 2036 rung currently consists of a 50/50 mix of some excess 2032s and some 2040s (with average maturity equal to 2036). The 2040s that I am holding will be sold, together with the excess 2032s, in 2026 to buy the 2036s. I have no intension of holding any 2040s to maturity. My 2040s are just placeholders that are approximately duration matched for the last remaining gap year in my ladder.

If I live to anywhere near age 84-85, I will then have some idea of whether I might need additional income beyond that point. If needed, I plan to buy longevity insurance in the form of immediate annuities at around age 85. My understanding is that the average duration of an annuity purchased at age 85 is about 5 years. Thus, the price of such an annuity is expected to rise or fall with changes in interest rates approximately in concert with the price of TIPS maturing in 5 years, at age 90, in 2042. So, my funds intended for annuity purchases are inflation protected and duration matched to minimize reinvestment risk by investing in 2042 TIPS. There is enough in that bucket to provide annuity income approximately replacing the income from the ladder. If I never need the annuities, the special needs trust for my disabled son will be that much larger. I recognize that the ongoing annuity income beyond age 85 would not be inflation protected. But there is also a risk portfolio (now primarily invested in equities) to draw upon if the base annuity income is not enough.

I'm not saying there is anything wrong with Kevin's approach. There are different paths to achieving liability matching. Pick the path that makes sense to you.  
That's interesting. Yes, everybody has a different approach. Thanks for sharing.

One question.... if you are only planning to buy TIPS out to 2036, instead of 2032s and 2040s, why not just buy 2034s now? I doubt if the yield you will get by splitting 2032s and 2040s would be very much different than just rolling 2034s into 2035s and then 2036s.
As you know, a non-rolling TIPS ladder is the low-risk way to provide an income floor in retirement. Regardless of interest rate changes, the real yield is known in advance since the bonds are inflation indexed and held to maturity. Credit risk is low for government issued treasuries. Reinvestment risk is eliminated by not rolling bonds.

When my ladder was built in 2018, I tried to stick to those LMP ladder principles as closely as possible. How to fill the gap years (then 2033 -2039) was the elephant in the room. Taking the 2036 rung as an example, I had to buy something to hold until the 2036s would become available later. I could have bought 2040s and sold early, but that introduces unnecessary interest rate risk. I could have bought 2032s and rolled them into 2036s, but that introduces unnecessary reinvestment risk. For that rung I decided to instead buy a mix of 2032s and 2040s with an average maturity matching the hypothetical 2036s (which, for this rung only, consists of exactly a 50/50 mix of 2032s/2040s). (Note that matching average maturity also approximately matches average duration, assuming that the hypothetical 2036s will have a similar coupon rate as the 2032s and 2040s.) Matching duration isn't perfect, but it minimizes sensitivity to interest rate changes as best as possible.

You could argue that buying 2032s and just rolling them into 2033s and then into 2034s and then into 2035s and then into 2036s would give about the same yield as splitting 2032s and 2040s. And you might be right, although I imagine the differences will only be quantifiable in hindsight.

In my limited understanding of investment theory, the former variable-duration approach introduces reinvestment risk that is not present by splitting 2032s and 2040s in a duration-matched manner. When the ladder was established in 2018, I chose the latter duration-matching approach simply because it seemed to have lower risk.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by protagonist »

Today I sold 30 4/2025s and 30 4/2026s in taxable , will be taking a capital loss on my 2024 taxes, and used the proceeds to buy more 2034s.
I also sold 30 2033s in my IRA and used the proceeds to buy 20 more 2040s. I might sell more in the future.

I'm not convinced that this was the best idea, especially since I will be paying higher taxes on regular income for years on the 2034s in taxable (coupon 1.75% vs. 0.125% for the 2025s and 2026s). I'm a little worried about my income possibly increasing beyond the threshold for SS becoming more taxable or having to deal with IRMAA, particularly starting in 2025 when I start taking RMDs. But I had considerably more invested in 2025s, 2026s and 2033s (as well as others) than I should need for expenses, so at worst, I don't think it was a very bad idea. And eventually, if I waited for the 2025s and 2026s to mature, if rates continue to be favorable I would likely wind up buying 2035s and 2036s at a high coupon rate with the proceeds anyway, and would still have the tax burden.

And I will be getting very close to 2% yield on the 2034s and more on the 2040s. I will use the ones I purchased to partially fund the gap years.

So maybe it was a good idea.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by watchnerd »

Could we get back up to 2.5-3% real yield?

If we're in a multi-decade secular rising rate super cycle, I don't see why not.

We were over 3% real yield 20 years ago.

https://tradingeconomics.com/united-sta ... tips-yield
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by yaun »

watchnerd wrote: Thu Apr 04, 2024 10:55 pm Could we get back up to 2.5-3% real yield?

If we're in a multi-decade secular rising rate super cycle, I don't see why not.

We were over 3% real yield 20 years ago.

https://tradingeconomics.com/united-sta ... tips-yield
One difference to the 1980s/1990s rate cycle and today is federal debt to gdp.

It had been reduced from 120% at the end of WW2 to 30% in 1980 when real yields started to rise again.
Currently it's 130%. Unless we see unprecedented productivity gains we cannot afford high real yields and more likely will see a continuation
of yield suppression similar to the 1940-1980 period. During those decades there were a few times when real yields rose above 2.5% but all of them were short lived.
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Re: Now that long TIPS yields are 60 bp off their highs I will…

Post by loukycpa »

I have found the TIPS ladder calculators where you plug in the desired inflation adjusted income stream you want and it tells you how much of each TIPS to buy to give you the desired income stream. Very helpful.

Is there a calculator out there where you can plug in the TIPS you currently own and the expected cash flows by year in today's dollars?

Have attempted to do my own rough calculations but would like to check my work.
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