"Simulated" bond ladder with TIPS ETF

[dandan14]

I'm hoping you all can help me think through something.

I'm in a position where I'd like to create a 5 year bond ladder. However, I think it would be easier (assuming I can wrap my head around it) to use a short term TIPS ETF to simulate the same ladder.

A 5-year bond ladder would have a duration of 2.5. VTIP has a duration of 2.4, so that is perfect.
Tipsladder.com tells me I can build a 5 year TIPS ladder with a withdrawal rate of 20.89% (real).

Here's what I'm trying to wrap my head around. If I did this using VTIP, using $100k initial purchase as an easy example, would I withdraw $20,890 each year (adj for inflation) and hit a $0 balance (or nearly 0) after the 5th withdrawal?
(I know it is unlikely to work out to exactly 0, because the fund duration is managed to stay at roughly 2.5, instead of adjusting downward.)

What would the impact be if rates went up or down? (My instinct is that with such a short duration, the impact of rate change would be negligible.)

[dcabler]

I'm hoping you all can help me think through something.

I'm in a position where I'd like to create a 5 year bond ladder. However, I think it would be easier (assuming I can wrap my head around it) to use a short term TIPS ETF to simulate the same ladder.

A 5-year bond ladder would have a duration of 2.5. VTIP has a duration of 2.4, so that is perfect.
Tipsladder.com tells me I can build a 5 year TIPS ladder with a withdrawal rate of 20.89% (real).

Here's what I'm trying to wrap my head around. If I did this using VTIP, using $100k initial purchase as an easy example, would I withdraw $20,890 each year (adj for inflation) and hit a $0 balance (or nearly 0) after the 5th withdrawal?
(I know it is unlikely to work out to exactly 0, because the fund duration is managed to stay at roughly 2.5, instead of adjusting downward.)

What would the impact be if rates went up or down? (My instinct is that with such a short duration, the impact of rate change would be negligible.)

If you're withdrawing annually, you would use the following excel function for this to get the percentage to withdraw every year.
PMT(rate, # remaining years, -1, 0, 1)
where rate=current real yield of VTIP at the time that you're making the withdrawal.
#remaining years = 5, then 4, then 3, etc.

I think that Vanguard's SEC yields that they publish are real yield (might want to check this) but on Nov 27th, it was 2.08%
Plugging that into the formula above and you get 20.83% for the first withdrawal, which is pretty close to tipsladder.com
Or, if you like, you can use the real yield published by iShares STIP which isn't an SEC yield, which on the 27th was 2.17%
Plugging that into the formula above and you get 20.87% which is even closer to tipsladder.com
STIP and VTIP both track indexes that are pretty much the same, so the results should be pretty close, which they are. One difference is that the SEC yield is based on 30 days and usually contains the effect of a fund's e/r whereas the real yield published by iShares doesn't take into account the e/r and is the yield only on that day.
Another source of real yield would be from #cruncher's Friday posts in this thread (look at the 0-5 index): viewtopic.php?p=8058225#p8058225

Now this is not going to be the same as a TIPS ladder. The reason is because the duration of VTIP (and STIP as well) are always going to be in the 2.4-2.5 year range. But your investment horizon is going to drop each year, so there is going to be a mismatch between your investment horizon and the nearly fixed duration of the bond fund after the first withdrawal. The result is that, in real terms, the withdrawals are going to move around from year to year some. The last withdrawal when # remaining years = 1 will results in a 100% withdrawal and will empty your holding.

If, alternatively, you make a first withdrawal and then adjust it for inflation, what's going to happen is that the last withdrawal will probably not be the same as all prior withdrawals, in real terms. It may have a shortfall or there may be a surplus.

Rate movements aren't going to change things much, as you guessed. The opposite movements in rates vs fund values will approximately counteract each other enough such that the withdrawals won't move around much, in real terms.

Cheers.

[PNWHiker]

If you really want a ladder and don’t want to manage the annual withdrawal calculations, you can ladder the appropriate maturities of iShares iBond target maturity TIPS ETFs (see https://www.blackrock.com/us/financial- ... ols/ibonds). The ER is higher than the maturity range TIPS ETFs (0.10 vs. 0.03), but maybe worthwhile in your case for the convenience.

[watchnerd]

If you really want a ladder and don’t want to manage the annual withdrawal calculations, you can ladder the appropriate maturities of iShares iBond target maturity TIPS ETFs (see https://www.blackrock.com/us/financial- ... ols/ibonds). The ER is higher than the target duration TIPS ETFs (0.10 vs. 0.03), but maybe worthwhile in your case for the convenience.

I actually thought this thread was going to be about those ETFs.

[dcabler]

If you really want a ladder and don’t want to manage the annual withdrawal calculations, you can ladder the appropriate maturities of iShares iBond target maturity TIPS ETFs (see https://www.blackrock.com/us/financial- ... ols/ibonds). The ER is higher than the target duration TIPS ETFs (0.10 vs. 0.03), but maybe worthwhile in your case for the convenience.

Just a nitpick, but these funds don't target a duration. They only target a range of maturities. In this case it's TIPS whose maturities are between 0 and 5 years. It usually works out that the duration ends up in a narrow range.

Cheers.

[PNWHiker]

If you really want a ladder and don’t want to manage the annual withdrawal calculations, you can ladder the appropriate maturities of iShares iBond target maturity TIPS ETFs (see https://www.blackrock.com/us/financial- ... ols/ibonds). The ER is higher than the target duration TIPS ETFs (0.10 vs. 0.03), but maybe worthwhile in your case for the convenience.

Just a nitpick, but these funds don't target a duration. They only target a range of maturities. In this case it's TIPS whose maturities are between 0 and 5 years. It usually works out that the duration ends up in a narrow range.

Cheers.

Fair point. Edited.

[dandan14]

Wow -- this is why I've been a lifelong Boglehead! Smart people, smart answers. Thanks everyone.

I had actually forgotten about the laddered ETFs (IBIG for example). A tiny bit higher ER (10 bp) but maybe worth it for the simplicity.