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Old 10-29-2008, 03:22 PM   #21
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Originally Posted by In-control View Post
I just read thru the tax treatment of TIPS and as a general rule I don't like to invest in things that that can't be explained, and understood by a 10 year old. I have looked at TIPS and they do not pass that litmus test, niether did morgage backed securities!
I have always held these in a tax-deferred account. Although the tax issues are relatively straightforward, there is a very real possibility (especially with low-coupon TIPS), that the "phantom interest" (i.e. the inflation adjustment) will exceed the coupon. In a period of high inflation, depending upon your tax-bracket, this could result in the coupon not covering the required income tax payment.

If you are going to hold these in a taxable account, you are probably better of with a TIPS mutual fund (e.g. VIPSX) where the inflation component is paid out along with the coupon interest, although with a mutual fund you give up having a fixed maturity date.
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Old 10-29-2008, 03:53 PM   #22
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Originally Posted by FIRE'd@51 View Post
Rusty,

I am curious why you chose the particular TIPS that you did...
I think TIPS mainly make sense to hold to maturity and that's
what I'll most likely do.

Honestly, my selection of a high-coupon one was because I'm
basically in retirement and want the cash flow.

BUt looking from a total return standpoint, I've heard it said
you want:

1. Long maturity - to lock in the good rate as long as possible.
2. Low coupon - to minimize the loss from not reinvesting the
coupon payments at rates as advantageous.
3. Low inflation factor - to minimize potential losses from deflation.
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Old 10-29-2008, 03:56 PM   #23
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Going out to 10years, do you really believe the inflation rate during this time will be 0.85% ?
I think what you mean is a cumulative inflation of -15%, right (or the
CPI is 85% of what it is now) ?

And no I don't. That's why I don't feel too bad about my selection.
If it DOES come to pass, we're in trouble for more than just our TIPS !!
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Old 10-29-2008, 05:01 PM   #24
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I think what you mean is a cumulative inflation of -15%, right (or the
CPI is 85% of what it is now) ?
What the breakeven rate is saying is that over the next 10 yrs we will have a 0.85% per year CPI rate of inflation. Over the last 10 yrs the minimum rate of inflation (in early 2002) was about 1.1% (12months rate) and the maximum was over 5% this year. So 0.85% is really stupid to bet on.
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Old 10-29-2008, 07:18 PM   #25
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Someone should put together a webpage with a Java applet that lets you enter a TIPS bond you'd like to buy (primary or secondary market) and an anticipated inflation curve over the (remaining) life of the bond. The applet would then generate the resulting expected principal adjustments and interest payments until maturity. This would let you see how these bonds actually work in various inflation scenarios, as well as calculate an inflation-adjusted net return.

I could write the software if I knew the correct algorithm.
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Old 10-29-2008, 07:54 PM   #26
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This means that deflation can cause this $1160 to retreat to $1000. So although you get the "par" principal of $1000 back at maturity, you are NOT guaranteed to get back the inflation-adjusted principal you may have paid on the secondary market. Capische ?
Oh but you are, and you said so yourself. Deflation increases your purchasing power so the $1,000 principal you get back buys as much as the $1,160 you originally invested. So your "inflation adjusted" principal is exactly what you get back (but with the downside capped at $1,000).

Deflation turns everything upside down and backwards.
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Old 10-29-2008, 07:57 PM   #27
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Originally Posted by socca View Post
Someone should put together a webpage with a Java applet that lets you enter a TIPS bond you'd like to buy (primary or secondary market) and an anticipated inflation curve over the (remaining) life of the bond. The applet would then generate the resulting expected principal adjustments and interest payments until maturity. This would let you see how these bonds actually work in various inflation scenarios, as well as calculate an inflation-adjusted net return.

I could write the software if I knew the correct algorithm.
I'm pretty sure you'd find that your inflation adjusted return equals the TIPS yield for securities held to maturity.

After tax returns are a different matter, with after tax real returns declining as inflation increases.
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