Educate me on TIPS

[HadEnuff]

I don't really understand them.

Every time I see a discussion about them, I am usually confronted with enough reasons why I don't like them that I never spend the time to truly understand them.
Here is what I think I know:

They aren't always easy to purchase.
They are sold at auctions. (I don't have a clue how this works)

What I know I don't know: How long are the maturity terms? Do they vary?

How much capital would you need to invest right now, if you could get them, to secure 50K/ year floor, inflation protected?

Do these questions even make sense?

 

[MBAustin]

I have never invested in TIPS directly but do hold some in a mutual fund (VIPSX).

Here are a few links:

Basic info:Treasury Inflation Protected Securities (TIPS) Definition | Investopedia

More details (click the links on the right side for specific subtopics):
The U.S. Treasury Market and Inflation-Protected Securities

A previous thread about building a retirement portfolio around TIPS:
http://www.early-retirement.org/forums/f28/an-analysis-of-a-tips-dominated-retirement-income-strategy-70384.html

Hope some of these are useful to you and perhaps others will chime in with more details.

 

[nun]

You can buy them on Treasury Direct or through a broker.

To find out how much a 30 year TIPS ladder would cost you just have to calculate how much you'd have to spend to buy $50k inflation protected income in say 30 years time, 29, 28, 27 etc and add them all up

Treasury Inflation-Protected Securities (TIPS) - Markets Data Center - WSJ.com

I think TIPS are bought in $1000 increments so for the 2045 TIPS you'd multiply the asking price by the accrued principal so for $1000 the accrued price is $897.52. The accrued principal is $1008 and the interest rate isn 0.75% so in 2045 the bond will pay $1008*(1+.0075) = $1015. To get $50k of inflation protected income you'd have to buy 50000/1015 TIPS shares = 49.26. The accrued asking price is $897.52 so you'd have to spend $897.52*49.26 = $44212. Now just do that for the rest of the years accounting for the annual coupon payments of the other bonds.....You are probably looking at $1.25M to buy $50k of TIPS income fro 30 years.

 

[Gone4Good]

A good source for learning about TIPS is Treasury Direct.

https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

You can buy them through Treasury Direct or through any brokerage account. You can buy them either on the secondary market, like any other bond, or at auction.

TIPS are issued with maturities of 5, 10 and 30 years. But because TIPS have been issued for many years, there are bonds available in the secondary market with almost any desired maturity.

The minimum purchase of TIPS through Treasury Direct is $100.

As to how much capital you'd need to secure a $50K income floor depends on how long you want that income to last and whether you plan to consume any of your original principal.

Currently 30 yr TIPS have a real yield of 1.2%, meaning you'd need to invest about $4.2MM to generate an inflation indexed coupon payment of $50K for 30 years without consuming any of your principal in real terms.

 

[Gone4Good]

I think TIPS are bought in $1000 increments so for the 2045 TIPS you'd multiply the asking price by the accrued principal so for $1000 the accrued price is $897.52. The accrued principal is $1008 and the interest rate isn 0.75% so in 2045 the bond will pay $1008*(1+.0075) = $1015. To get $50k of inflation protected income you'd have to buy 50000/1015 TIPS shares = 49.26. The accrued asking price is $897.52 so you'd have to spend $897.52*49.26 = $44212. Now just do that for the rest of the years accounting for the annual coupon payments of the other bonds.....You are probably looking at $1.25M to buy $50k of TIPS income fro 30 years.

It's important to note that this method doesn't generate $50K in "income." To spend $50K per year this way means spending down your principal. At the end of 30 years, you'll have $0 left of your initial ~$1.25MM position.

That's not to say there isn't good reasons for doing things this way. It's just important to understand that you're mostly spending principal with this approach.

 

[nun]

It's important to note that this method doesn't generate $50K in "income." To spend $50K per year this way means spending down your principal. At the end of 30 years, you'll have $0 left of your initial ~$1.25MM position.

That's not to say there isn't good reasons for doing things this way. It's just important to understand that you're mostly spending principal with this approach.

Yes, I did it this way because the usual SWR from a portfolio assumes that you are consuming principal. If you have $4.2M and need $50k/year that's a WR of 1.2% and I think you can afford to take a lot more risk than a TIPS ladder. Maybe use $1.25M on the TIPS ladder and put the rest in riskier stuff and some real estate.

 

[photoguy]

TIPs are very attractive because you can buy longer maturities (with higher real rates) without risking your bonds being destroyed by inflation.

You don't have to buy them individually -- there index funds available (Vanguard has a few).

I currently have 0 dollars in TIPS although I do have a column for them on my portfolio spreadsheet. If/when the real rates ever rise, I expect to buy a significant chunk.

 

[nun]

TIPs are very attractive because you can buy longer maturities (with higher real rates) without risking your bonds being destroyed by inflation.

You don't have to buy them individually -- there index funds available (Vanguard has a few).

I currently have 0 dollars in TIPS although I do have a column for them on my portfolio spreadsheet. If/when the real rates ever rise, I expect to buy a significant chunk.

Doesn't buying them in funds have the same issues as doing that for other bonds?

 

[photoguy]

If the bond is not matched to a specific liability, I don't see any substantive difference between a bond fund and buying individual bonds.

The most common objection is that you can lose principle in a bond fund. I don't think this is a reasonable objection because you've lost the exact same amount of money (assuming matching durations) with individual bonds. You just don't see it with individual bonds because they aren't marked-to-market on daily basis. However if you try and sell it, you'll definitely feel the loss.

I don't have any objection to buying individual government bonds though. It just seems easier to buy the fund than to try and establish my own ladder. Plus I'm guessing my portfolio is too small and I would pay more in transaction costs than just buying a fund from vanguard.

 

[nun]

If the bond is not matched to a specific liability, I don't see any substantive difference between a bond fund and buying individual bonds.

The most common objection is that you can lose principle in a bond fund. I don't think this is a reasonable objection because you've lost the exact same amount of money (assuming matching durations) with individual bonds. You just don't see it with individual bonds because they aren't marked-to-market on daily basis. However if you try and sell it, you'll definitely feel the loss.

I don't have any objection to buying individual government bonds though. It just seems easier to buy the fund than to try and establish my own ladder. Plus I'm guessing my portfolio is too small and I would pay more in transaction costs than just buying a fund from vanguard.

If you are planning to take income out every year wouldn't it be best to have the definite maturities of a ladder so you are guaranteed to get your principal back?

 

[photoguy]

Yeah I guess if the OP wants to spend down the principal to fund living expenses, then having individual bonds makes sense (i.e. matching the bond to a specific liability -- the spending for a given year). I wouldn't take this approach myself (being total return) but I think it's fine.

Hopefully the OP can chime in and clarify what he/she wants.

 

[haha]

You might find all you will need on the web. But this is something that you should really understand before you do any investing, and from what you said in OP your current understanding is incomplete. If I were planning on investing a million or millions, I might be open to spending $15 on a book. However, as is often said, ymmv.

Under current conditions I think TIPS offer more opportunely for loss than gain, but that is just an opinion.

Here is a book which I found useful.

Robot Check

Ha

 

[nun]

Under current conditions I think TIPS offer more opportunely for loss than gain, but that is just an opinion.

That's why I'd buy the TIPS directly rather than a fund....or are you talking about deflation?

 

[haha]

That's why I'd buy the TIPS directly rather than a fund....or are you talking about deflation?

Historically long term rates at times have changed with no change in inflation rates, or as in the late 19th century in England, no inflation to speak of.

I have no special knowledge of TIPS, though I formerly owned them. I do know that it is easy to miss some of the nuances.

I guess none of this matters if the buyer is only interested in getting back what the US government decides is an inflation adjusted principal and interest on the investment.

Ha

 

[Gone4Good]

I have no special knowledge of TIPS, though I formerly owned them. I do know that it is easy to miss some of the nuances.

Like the fact that at high rates of inflation taxes can significantly diminish your real return.

Even if you don't think the government is monkeying with CPI as Ha is perhaps subtly suggesting, you'll only get to spend your promised "real return" if inflation stays reasonably low.

 

[HadEnuff]

Yeah I guess if the OP wants to spend down the principal to fund living expenses, then having individual bonds makes sense (i.e. matching the bond to a specific liability -- the spending for a given year). I wouldn't take this approach myself (being total return) but I think it's fine.

Hopefully the OP can chime in and clarify what he/she wants.

I'm just looking, at this point, to understand what these things are, how they might fit into a portfolio, and to hear opinions on their pros and cons.

 

[daylatedollarshort]

I liked The Bond Book by Annette Thau for understanding the pros and cons of different kinds of fixed income investments, including TIPS.

 

[nun]

OP FYI, this is an interesting discussion

https://www.bogleheads.org/forum/viewtopic.php?f=2&t=182799