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Can someone explain TIPS to me please?
Old 09-30-2008, 01:06 PM   #1
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Can someone explain TIPS to me please?

About all I know about TIPS is that they are some semi low risk Treasury bill type investment that is linked to the inflation rate. LOL...Pretty horrid explanation I know.

Up until this year I was 100% invested in stocks but now with 6.5 years to go until retirement (maybe 7.5 years now) I have 60% stocks / 15% bonds / 10% TIPs / 15% Real Estate.

Now I know putting 10% of my money in TIPS without understanding them is pretty foolish....hence my question now. Better late than never.

Anyone willing to give me a quick explanation of what they are exactly, and what purpose they serve to a portfolio so I can figure out if I really want to keep them? More specifically, is there any benefit to having 10% TIPS as oppossed to that 10% being in bonds of some sort?

Currently my 15% bonds is in PTRAX and the 10% TIPS is in VIPSX
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Old 09-30-2008, 01:20 PM   #2
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TIPS are just a form of bond that has a yield that varies with the inflation rate. The idea is to give your portfolio a little bit of protection against inflation.

Many people choose to split their bond allocation into one-half TIPS and one-part other conventional bonds or bond funds.
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Old 09-30-2008, 01:23 PM   #3
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TIPS are government bonds that are risky. They are not safe and can lose money. This is despite what many journalists and media types write about them. They are, however, less risky than many other kinds of investments such as stocks, commodities, corporate bonds. They are not tax efficient, so hold them in tax-advantaged accounts.

From Bogleheads :: View topic - TIPs went down lots why??
Quote:
Originally Posted by larryswedroe
Here is how it works,

Nominal bonds have three components.
A) Real rate--same as TIPS
B) expected inflation rate
C) risk premium for unexpected inflation

TIPS have two components
a) the real rate
b) should be a very tiny premium for liquidity vs nominal Treasuries.

In theory now B should be close to zero as they are now very liquid with tiny bid/offer spreads.
Here is a link to a link: Bogleheads :: View topic - Article: Benefits and Management of TIPS

So the NAV of your VIPSX will fluctuate depending on the bonds it hold and the prevailing interest rate. The dividends of the bonds in VIPSX will pay whatever dividend rate they were bought at PLUS an inflation component that is set every 6 months. The combined payment is about a 5% yield which is similar to payments made on other government bonds (like GNMA bonds).

Now how TIPS behave when inflation increase is different than for other bonds. The dividend goes UP, while for other bonds the NAV goes down so that the dividend rate goes up. But when interest rates go up, the NAV for all bonds (including TIPS) goes down. Confusing?

So if you had bought TIPS bonds themselves and held to maturity, you would not lose value, but you probably wouldn't gain much value either. If you traded the bonds to realize capital gains then bought them at a lower price, you would probably come out ahead.

That's my 2 cents. Please correct me if I wrong.
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Old 09-30-2008, 01:27 PM   #4
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Have you tried this site: Individual - Treasury Inflation-Protected Securities (TIPS)
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Old 09-30-2008, 02:56 PM   #5
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I'll just add that (IMHO), now is a DAMN good time to be buying some of
the longer-term TIPS (the 20yr in particular). The yields-to-maturity are
exceeding 2.6% (see Bloomberg.com: Government Bonds),
which is mighty good, both looking at historical YTMs, and based on the
simple fact that an investment with 2.6% real yield can support a 4%
inflation-adjusted withdrawal rate for almost 40 years (with portfolio depletion).
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Old 09-30-2008, 03:11 PM   #6
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Providing you die on time and your personal inflation rate is less than or equal to the CPI.

In a nutshell, no better an investment than similar duration garden variety treasuries unless we see a long period of very high inflation.
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Old 09-30-2008, 04:20 PM   #7
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CFB and I have disagreed on TIPS in the past. Personally, I'm a big proponent of TIPS, and a lot of TIPS.

Here's an article on how to go to an all TIPS portfolio that shows how to make CPI-U cola'd withdrawals for certainty up to 30 years. If you want 40 years, you'll probably have to lower withdrawal rate down to 3.5-3.0%, which you'll likely have to do with anyother withdrawal strategy. It's basically an immunization strategy.

Here's how TIPS work.

- Alec
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Old 09-30-2008, 05:14 PM   #8
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Originally Posted by ats5g View Post
CFB and I have disagreed on TIPS in the past. Personally, I'm a big proponent of TIPS, and a lot of TIPS.

- Alec
I'm in your camp on this one. Right now I would rather own selected stocks- but much of the time TIPS at today's yields wold be best.

Ha
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Old 09-30-2008, 05:49 PM   #9
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Quote:
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TIPS are government bonds that are risky. They are not safe and can lose money. This is despite what many journalists and media types write about them. They are, however, less risky than many other kinds of investments such as stocks, commodities, corporate bonds. They are not tax efficient, so hold them in tax-advantaged accounts. (snip) So the NAV of your VIPSX will fluctuate depending on the bonds it hold and the prevailing interest rate. The dividends of the bonds in VIPSX will pay whatever dividend rate they were bought at PLUS an inflation component that is set every 6 months. The combined payment is about a 5% yield which is similar to payments made on other government bonds (like GNMA bonds).

Now how TIPS behave when inflation increase is different than for other bonds. The dividend goes UP, while for other bonds the NAV goes down so that the dividend rate goes up. But when interest rates go up, the NAV for all bonds (including TIPS) goes down. Confusing?

So if you had bought TIPS bonds themselves and held to maturity, you would not lose value, but you probably wouldn't gain much value either. If you traded the bonds to realize capital gains then bought them at a lower price, you would probably come out ahead.

That's my 2 cents. Please correct me if I wrong.
Does what you've said above apply to individual TIPS or only to a TIPS bond fund? I wouldn't have thought it was possible to lose on individual TIPS if they are held to maturity, because they are guaranteed to earn more than the inflation rate.

Karen
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Old 09-30-2008, 05:54 PM   #10
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There are good arguments for TIPS. I am thinking of exchanging my GNMA fund to a TIPS fund (VFIIX -> VIPSX) now that things are different than last November when I did the opposite (VIPSX -> VFIIX).

The arguments against TIPS are essentially (a) the inflation component doesn't really track inflation and (b) deflation will kill you. So even with the bonds, I think you can lose money (i.e. spending power).
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Old 09-30-2008, 05:55 PM   #11
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Originally Posted by cute fuzzy bunny View Post
Providing you die on time and your personal inflation rate is less than or equal to the CPI.
Isn't that true of any investment? What does it have to do with TIPS?

-ERD50
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Old 09-30-2008, 06:05 PM   #12
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Originally Posted by ERD50 View Post
Isn't that true of any investment? What does it have to do with TIPS?
-ERD50
Nothing. It's just a frequently used red herring on this board.

Ha
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Old 09-30-2008, 06:39 PM   #13
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Nothing. It's just a frequently used red herring on this board.

Ha
I knew that - ERD50
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Old 09-30-2008, 06:55 PM   #14
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T
The arguments against TIPS are essentially (a) the inflation component doesn't really track inflation and (b) deflation will kill you. So even with the bonds, I think you can lose money (i.e. spending power).
I'm in the pro Tips camp but I only buy individual Tips not funds.

The face value of the TIPS bond will not be reduced due to deflation, however any gains will disappear as deflation continues/increases. In a deflationary economy (very rare here, think 1930's) any money you do have is worth more so it could be a wash as far as purchasing power goes.

I would worry more about the government fudging the infaltion numbers more than deflation.
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Old 09-30-2008, 08:59 PM   #15
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Not anti anything. What I said in fewer words was that the bond market is efficient over time. If TIPS were too good of a deal or a lousy deal relative to regular treasuries of the same duration, prices would adjust until there was near parity.

And look...5 year return on TIPS is 6.51%...5 year return on long term treasuries...6.51%.

Its probably also worth pointing out that most TIPS funds are still hanging onto some of the original long term issues that paid a ridiculous rate you'll never see again, like 3.5-4% real. As those are augmented and eventually replaced with todays much lower rate products, the shine will go off a bit.
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Old 09-30-2008, 09:39 PM   #16
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Quote:
Originally Posted by LOL! View Post
...So if you had bought TIPS bonds themselves and held to maturity, you would not lose value, but you probably wouldn't gain much value either. If you traded the bonds to realize capital gains then bought them at a lower price, you would probably come out ahead.

That's my 2 cents. Please correct me if I wrong.
If you buy TIPS bonds individually you have a better chance of controlling your destiny. They protect against unexpected inflation as has been mentioned above. As mentioned above today you could buy 2.6% 20yr TIPS. That means if real rates go above this just hold to maturity. If next year we have 3% inflation (CPI) then you earn around 5.6%. If it's 7% inflation then you'll get 9.6%.

The inflation factor accumulates and if we have deflation it will go down. But you are at least guarenteed the par value back so it can never go below that at maturity. So there is a little risk of deflation but it's very modest indeed. Personally I think the risk is towards more inflation and if deflation then for only a short time. Note also the coupon on your TIPS is paid out directly to you twice per year -- it's the inflation adjustment that sticks with the bond.

If you bought a 20yr TIPS it's duration is around 16 yrs. If the real rate goes up then they loose money but that's why you buy these to hold to maturity. If the rate goes down you can do quite well. TIPS tend to be negatively correlated to stocks. If their rate goes down you have a natural ballast to stocks without the weakness inherent in long term treasuries should there be inflation (with nominal rates going up). In the last decline I had 10yr TIPS purchased at around 2.5% and they declined to 1.4% before I sold. The gain in 6 months was (2.5% - 1.4%) * 8 = 8.8% (duration was 8 yrs). So that helped my portfolio a lot while rates declined. Of course, that was the last war.

TIPS can be a little complicated but in my opinion are a great thing for retirees concerned about inflation. So were those high rate Ibonds which aren't around any longer.
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Old 09-30-2008, 09:53 PM   #17
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IMO, with TIPS you're buying inflation insurance. Your "insurance premium" is any inflation premium that the holders of nominal bonds receive in the future. Now, whether or not this insurance is worth paying for is up to you and how much inflation risk you have.

For example, a 30 yo male w/ 2 young kids should be willing to pay more for life insurance than a 30 yo male with no dependents. The 30 yo male with no dependents would likely be willing to pay nothing. Likewise, someone with no inflation protection [like TIPS or a cola'd pension] should be wiling to pay a higher inflation insurance premium that someone with inflation protection [like Nords].

- Alec
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Old 10-01-2008, 08:23 AM   #18
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Agree witht the inflation insurance comments. Seems to me that anyone investing in bonds should consider what they would expect to recieve in real returns. TIPS guarantee this and allow you to basically hold a long bond without getting burned should we experience unexpected inflation. Nominal bonds build in today's guess at the inflation to be experienced over the maturity of the bond.
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Old 10-01-2008, 08:35 AM   #19
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Couple of other things.

If you only have 20% of your money in TIPS, only 20% is "inflation protected". The rest is or isnt dependent on the characteristics of your other asset classes. If you have 100% in TIPS, during periods of low inflation your returns will stink.

So its a good idea to look at inflation protection as a systemic matter. Otherwise you've flat proofed one tire on your car...

Look at the high inflation periods in the historic data. A mix of 25-35% value stocks and the rest plain old bonds offered inflation protection as good or better than a 100% tips portfolio.
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Old 10-01-2008, 09:36 AM   #20
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Ive never really understood any kind of bonds in general (as oppossed to stocks and even options). After reading all of the in depth material in this thread, I still have no idea whether I need or want TIPs in my portfolio.

Knowing nothing about me other than I have 7ish years until retirement, I have a generous pension and I am currently 60% stocks / 15% PTRAX / 15% Vanguard REIT / 10% TIP.....is there any reason not to get rid of the TIPs and go 25% PTRAX?

The main reason I want to do this is the fact that the VIPSX fund is in a taxable account and I have no bond option in my 457 account other than PTRAX.
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