New tool for building a TIPS ladder

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kaesler
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Re: New tool for building a TIPS ladder

Post by kaesler »

mountaincity wrote: Sat Jun 08, 2024 6:36 pm Thank you for developing this calculator! So I may be showing my ignorance, but how can annual or total income be calculated?

As I thought that the rate of inflation (calculated annually?) affects the principal amount?
The amount shown is in today’s dollars. When the future payments are actually received the numbers will be greater/lower according to the inflation/deflation that has occurred between now and then.
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Raspberry-503
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Re: New tool for building a TIPS ladder

Post by Raspberry-503 »

The idea to buy TIPS is to know how much you will make on top of inflation. $10,000 in tips will buy you as many gallons of milk today as their value in 20 years will at that time.
Since we don't know inflation we don't know the actual dollar amount in the future.
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gmaynardkrebs
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Re: New tool for building a TIPS ladder

Post by gmaynardkrebs »

stevewolfe wrote: Sat Jan 07, 2023 8:10 pmFor example, some folks may prefer to select bonds with low coupon
I'd find a low coupon prong useful to get as close to a TIPS zero-coupon as possible, as I doubt my heirs will remember to reinvest the coupon interest.
mountaincity
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Re: New tool for building a TIPS ladder

Post by mountaincity »

Thank you, Understood now, the principal "growth or depreciation" is ignored.

Further dumb question on understanding the results, and what the annual income is derived from:

For example w/ arbitrary $ amounts:

I want to construct a 10 year ladder and derive 25K income per year.

I purchase the identified TIPS in the listed quantities with an initial purchase price of $250,000.00 (?)

I would receive 25K income per year which is made up ? of interest earned plus the principal return of maturing TIPS.

So the principal of $250,000 is returned plus interest and "possible" principal inflation. The principal returned is never less than the original investment.
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Raspberry-503
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Re: New tool for building a TIPS ladder

Post by Raspberry-503 »

the TIPS interest are counted in the ladder payments. so you will end less than $250,000 because the tips you consume in year 10 will be paying dividends every single year from the year of purchase. If year 1 of your ladder is still 5 years away, that means the last TIP will have been paying interest for 14 years before you sell it.
So in early years, part of your yearly income is composed from interest on TIPS you'll sell later and TIPS you will sell that year.
Play with the tools it will show you the buy price if you were to buy today.

IF the ladder starts in 5 years, you can decide to count that first five year interest towards the first year, or you can decide you will spend it (or invest it into stock or whatever) as you receive it before the ladder starts. The tool allows both options

and again because interest paid is calculated on the inflation adjusted value of the bond, you need to think in real money (no inflation). the interest is shown in today's dollar (say $100), but by the time you get that money in 8 years, the interest will buy you as many gallons of mile as $100 would today.
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sycamore
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Re: New tool for building a TIPS ladder

Post by sycamore »

mountaincity wrote: Mon Jun 10, 2024 11:48 am Thank you, Understood now, the principal "growth or depreciation" is ignored.

Further dumb question on understanding the results, and what the annual income is derived from:

For example w/ arbitrary $ amounts:

I want to construct a 10 year ladder and derive 25K income per year.

I purchase the identified TIPS in the listed quantities with an initial purchase price of $250,000.00 (?)

I would receive 25K income per year which is made up ? of interest earned plus the principal return of maturing TIPS.

So the principal of $250,000 is returned plus interest and "possible" principal inflation. The principal returned is never less than the original investment.
Raspberry-503's suggestion to try out the tool is an excellent one.

Example: desired annual real income=$25,000, for the 10 years from 2025 to 2034, using the default options. (The image below shows what I see on June 11, 2024. If you run this on a later date you'll get slightly different numbers.)

Image

Notice:
1) The bottom line for Net Purchase Cost = $224,758. Total Income = $251,309.

2) Each row shows a column for Pre-ladder Interest, Principal Income, Interest Interest, which together add up to the final column Total Income.

3) What happens to the Pre-ladder Interest as the years go by? In this case, it's only there for one year because "pre-ladder" refers to the time before the first rung matures. So it's the coupons from all 10 TIPS that you'll receive in 2024. What to do with this income (as well as Interest Income) is a common question for those buying TIPS. That's more of an advanced topic :)

4) What happens to the Principal Income as the years go by? Starts off at $21,126 and generally rises.

5) What happens to the Interest Income as the years go by? Starts off at $2912 (which comes from all 10 of your TIPS, not just the 2025 maturity TIPS) and drops to $223 at the end (which is only from the 2034 TIPS).

6) Total Income is not exactly $25,000 each year but over 10 years it averages out to $25,130.90. A single TIPS face value is $1,000 so that's the granularity we have to deal with.

7) "The principal returned is never less than the original investment." That's not necessarily so for every TIPS purchase. Look at the 2027 -- you pay $21,853 for $21,711 in principal. What happened there? Click the green "Show details" button and you'll see more columns. Look at the "Accrued interest cost" column = $210. For each TIPS purchase, part of your purchase price includes the interest that has accrued thus far in the 6 month period - that amount will go to the seller, who's been holding the TIPS for that period. For the 2027 it happens to be large amount of accrued interest -- related to the larger coupon of 2.375%. Nothing wrong here, you're not overpaying; just something to know about.
EricGold
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Re: New tool for building a TIPS ladder

Post by EricGold »

This thing is magic. The beer is on me
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#Cruncher
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Re: New tool for building a TIPS ladder

Post by #Cruncher »

sycamore wrote: Tue Jun 11, 2024 6:50 am 7)
mountaincity wrote: Mon Jun 10, 2024 11:48 amThe principal returned is never less than the original investment.
That's not necessarily so for every TIPS purchase. Look at the 2027 -- you pay $21,853 for $21,711 in principal. ...
A much better example of cost exceeding principal is the 3-3/8% TIPS maturing April 2032. Its $26,931 cost exceeds the $24,667 principal by over $2,000. This is because that TIPS throws off $6,243 interest in addition to its principal. [1] This plus the principal exceeds the cost by about $4,000. We can see this in the table below from the "ToPaste" of my TIPS Ladder Builder Excel workbook. [2] As shown in the far-right column, the total proceeds of all ten TIIPS exceed the cost. This is to be expected for any bond with a positive yield-to-maturity.

Code: Select all

                                                                      Proceeds in 6/11/2024 Dollars
                                                                    ----------------------------------
                                      Total -->    10  183  226,053   234,120  1,471   15,571  251,162   25,109
                        Ask                            Nbr                     Final Previous    Total Proceeds
  Matures   Coupon     Price    Yield    CUSIP   Mult Bnds    Cost  Principal Coupon  Coupons Proceeds  vs Cost

Code: Select all

 1/15/2025  0.250%   97.93750  3.780%  912828H45    1   17   22,006    22,446     28            22,475      468
 1/15/2026  0.625%   96.59375  2.836%  912828N71    1   17   21,670    22,375     70      140   22,585      915
 1/15/2027  2.375%   99.68750  2.496%  912810PS1    1   14   21,853    21,711    258    1,031   23,000    1,147
 1/15/2028  1.750%   97.96875  2.341%  912810PV4    1   16   23,570    23,885    209    1,254   25,348    1,778
 1/15/2029  0.875%   94.18750  2.211%  9128285W6    1   19   22,248    23,532    103      824   24,459    2,211
 1/15/2030  0.125%   89.43750  2.141%  912828Z37    1   19   20,668    23,095     14      144   23,254    2,586
 1/15/2031  0.125%   87.84375  2.109%  91282CBF7    1   19   20,063    22,826     14      171   23,011    2,949
 4/15/2032  3.375%  108.65625  2.168%  912810FQ6    1   14   26,931    24,667    416    5,827   30,910    3,979 <===
 1/15/2033  1.125%   91.96875  2.152%  91282CGK1    1   23   22,319    24,147    136    2,173   26,457    4,138
 1/15/2034  1.750%   96.50000  2.157%  91282CJY8    1   25   24,726    25,435    223    4,006   29,663    4,938
  1. On the tipsladder.com detail we see that the inflation adjusted value for each of the 14 bonds is $1,761.90. Over the 7 full years 2025-2031 and the half year 2032 the 3.375% coupon produces interest of
    $6,243 = 14 * 1761.90 * 3.375% * 7.5
  2. This workbook builds a TIPS ladder using the same basic approach as the tipsladder.com tool, but is harder to use. I updated it with Monday's WSJ TIPS Quotes, selected the same ten TIPS, and made other tweaks so it would produce similar results.
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