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I thought I Understood TIPS....
Old 04-30-2006, 09:16 PM   #1
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I thought I Understood TIPS....

but I have to admit I don't and ask for an explanation. I am in the VG TIPS fund. I thought that, since there is a guaranteed return of the rate of inflation, the fund would go up by at least that amount. The fund is going down. Why is that?
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Re: I thought I Understood TIPS....
Old 04-30-2006, 09:52 PM   #2
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Re: I thought I Understood TIPS....

Quote:
Originally Posted by smooch
but I have to admit I don't and ask for an explanation. I am in the VG TIPS fund. I thought that, since there is a guaranteed return of the rate of inflation, the fund would go up by at least that amount. The fund is going down. Why is that?
Smooch: The Tips Fund (like most bond funds) hasn't done well for the last couple of years because of interest rate increases. (Drop of NAV). If this is long term investment, you probably will do O.K. with that particular fund, as your bond interest has been buying more shares at a lower price. (Assuming you're reinvesting).

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Re: I thought I Understood TIPS....
Old 05-01-2006, 03:31 AM   #3
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Re: I thought I Understood TIPS....

tips have 2 parts to them ,,a very low guaranteed interest rate somewhere between 1to 2% right now ..the next part is based on the cpi,its adusted every 6 months..problem was last adjustment caught a cpi spike and the result was tips were paying 6.6% or better....now it looks like they will re-adjust to around 3 or so.....tips funds are down around 2.80 % for the year getting ready for the new rate
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Re: I thought I Understood TIPS....
Old 05-01-2006, 06:27 AM   #4
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Re: I thought I Understood TIPS....

Smooch,

You've discovered the big difference between owning a bond fund and owning the bonds themselves (and holding them to maturity). A bond fund goes up and down in price with the interest rate: when interest rates rise, your bond fund decreases in value (this is necessary so that buyers will be getting the same effective yield whether they buy the fund or buy the newer, higher-rate bonds). When you sell your bond fund shares, whether today or in 30 years, thay might be worth more or less than what you paid for them. Of course, the bonds inside the fund continue to pay interest over the years, and you've probably been re-investing that interest in more bond fund shares over time, so even if the share price stays level, you'll have more money in your account.
If you owned TIPS themselves, you'd have a firm gaurantee that the interest you receive periodicaly would be the inflation rate plus the "real" interest stated at the time you bought the bond. No ups and downs.
Bond funds are more convenient to buy and keep track of than are individual TIPS, and they can sometimes produce better results over short periods than buying the bonds themselves. But, buying TIPS directly from the treasury can be done at very low cost and there's no annual expense fee to pay.
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Re: I thought I Understood TIPS....
Old 05-01-2006, 08:09 AM   #5
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Re: I thought I Understood TIPS....

Quote:
Originally Posted by samclem
Bond funds are more convenient to buy and keep track of than are individual TIPS, and they can sometimes produce better results over short periods than buying the bonds themselves. But, buying TIPS directly from the treasury can be done at very low cost and there's no annual expense fee to pay.
I agree with everything you wrote, but want to add something... The last time I checked, they did not offer IRA accounts at TreasuryDirect. Holding TIPS in a taxable account is generally a bad idea because the inflation adjustments are considered taxable income even though you don't see that money until you redeem (or sell) the bond.

I hold the Vanguard TIPS fund in my IRA and figure that the ups and downs of the bond fund give some additional diversification to the portfolio. If you prefer to own individual TIPS bonds, you're probably better off buying them in an IRA account instead of in a (non-IRA) TreasuryDirect account, despite the extra commissions.

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Re: I thought I Understood TIPS....
Old 05-01-2006, 10:48 AM   #6
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Re: I thought I Understood TIPS....

Quote:
Originally Posted by sc
I agree with everything you wrote, but want to add something... The last time I checked, they did not offer IRA accounts at TreasuryDirect.
But you can buy TIPS at auction through Fidelity, for holding in your IRA. I'm sure Vanguard will do the same.

Also, while it's true that holding individual TIPS ensures that you see the inflation-adjusted interest deposited to your account every 6 months, the value of the TIPS, as shown in your account summary, still goes up and down with interest rate changes.

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Re: I thought I Understood TIPS....
Old 05-01-2006, 11:33 AM   #7
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Re: I thought I Understood TIPS....

Quote:
Originally Posted by Peter
But you can buy TIPS at auction through Fidelity, for holding in your IRA. I'm sure Vanguard will do the same.
Right, that's what I was trying to say. I may have misunderstood samclem's post, though. When he advised buying TIPS directly from the treasury, I took that to mean through TreasuryDirect, which is really a great deal if you are going to buy individual treasuries. Problem is, they don't offer IRA accounts, which is a real disadvantage where TIPS are concerned. Like you said, most brokerages also allow you to buy TIPS at auction for little or no commission in an IRA account.

Still, Vanguard's TIPS funds are pretty cheap - 0.20% ER for investor and 0.11% ER for admiral.

The tax on the inflation adjustment is a major downside to TIPS. I read that this "feature" was an oversight and TIPS weren't intended to be taxed that way, but good luck getting that fixed now.

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Re: I thought I Understood TIPS....
Old 05-01-2006, 01:13 PM   #8
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Re: I thought I Understood TIPS....

sc,

- I've never bought Treasuries through Fidelity (where I have my 401K), but I believe it is possible to buy initial issues through them for less commission than buying traesuries on the secondary market (through them). When I was considering I-Bonds several months ago, and I even asked Fidelity how they made money on the trade, as it seemed much cheaper than buying existing bonds. Anyway, I didn't buy at the time, so I don't know what the commission would be for the purchase of new issues.

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Re: I thought I Understood TIPS....
Old 05-01-2006, 02:02 PM   #9
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Re: I thought I Understood TIPS....

Quote:
Originally Posted by samclem
sc,

- I've never bought Treasuries through Fidelity (where I have my 401K), but I believe it is possible to buy initial issues through them for less commission than buying traesuries on the secondary market (through them).**
samclem
I don't know about I-bonds, as these are not traded. But I buy TIPs as well as notes and bills at auction in my Fidelity account for no commission at all using web-based trading.

I don't think they do make any money on these transactions. I think they do it to keep funds in house that they know from experience will ultimately make them some money.

Ha
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Re: I thought I Understood TIPS....
Old 05-01-2006, 06:26 PM   #10
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Re: I thought I Understood TIPS....

Haha
-- oops-I meant TIPS, not I-Bonds.
Thanks for the info--glad I remembered it right
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