Real Interest Rates Charge Ahead

[haha]

Off Bloomberg.com this morning-

Real Coupon to maturity:

5 years--2.60 %
10 years-2.65
20 years-2.64

I think 18 months ago or so these rates were below 2%.

Only thing I can figure is that the rates rises in the straight treasury market have exerted an upward pressure on real rates.

From an absolute return standpoint, these rates are looking better every day. Still, it would suck to commit heavily now, and see them go back to 4%.*

A million at 2.5+% real, added to social security would give a pretty good backstop for whatever other investments one might have. Especially if that "one" is not totally sold on the robustness of the 4% SWR.

Ha

[brewer12345]

Yeah, real rates are starting to look quite attractive. If they get to 4+%, I will be liquidating lots of stuff to buy TIPS.

If you want to buy some here and not take tons of risk related to real rates rising, buy the 5 year TIPS.

[. . . Yrs to Go]

At current rates TIPS begin to make sense as a way to diversify your fixed income portfolio. At 3%+ they begin to make a lot of sense relative to a similarly sized withdrwal rate.

I plan to leg into 20-yr TIPS at the up coming July auction. I have no use for 5-yr TIPS because my goal is to lock in real rates that work with my withdrawl strategy. I'm not going to load the boat at 2.6% but if rates keep going up I'll happily buy more.

[GTM]

If TIPS real rate ever gets to 3% what percent of investment money do you think should go into them?

How about 3.5%?

4%? (may not be very realistic but...)

[virginia]

Can someone explain what TIPS are? I looked it up, but don't get it. If rates are under 3%, are you also saving somewhere else? How is this better than a CD or bank savings account. Does the interest equal the price of the TIP+inflation+ the 2+%? Also, how long do you buy and hold them for (or the minimum I should say).
Michelle

[d]

explain what TIPS are?

"treasury inflation protected securities" have two parts to the return: the interest rate and an inflation adjustment (applied to* the principal).* effectively, the return is inflation plus interest. (stated somewhat differently, the interest rate is the "real" rate, whereas in non-inflation protected bonds the "real" rate would be the "stated" rate minus inflation.) they are issued in 5, 10 and 20 yr terms.

[cute fuzzy bunny]

To the extent that "CPI=inflation" then the rate is "real" and the term "inflation" is used correctly.

Since most economists dont agree that CPI exactly equals inflation, and inflation varies by geographic location, age, lifestyle and a number of other factors, its a good idea to find out what the relationship is with your personal inflation rate and compare that to the consumer price index, which is the statistic used to calculate the "inflation" component of TIPS.

If your personal rate of inflation is not approximately equal to the CPI, then the rate of return is not "real".

It seems to me that looking back over the time period since TIPS were offered, that the total return didnt vary that much vs a treasury of the same term when the coupon was below about 3.5%.

Good luck seeing over 3.5%.

[. . . Yrs to Go]

Originally Posted by Cute Fuzzy Bunny

If your personal rate of inflation is not approximately equal to the CPI, then the rate of return is not "real".

It seems to me that looking back over the time period since TIPS were offered, that the total return didnt vary that much vs a treasury of the same term when the coupon was below about 3.5%.

Two related thoughts:

Compensation for future expected inflation is imbedded in the current yield of all bonds. The price and yield of bonds fluctuate with changes in inflation expectations (among other things). These inflation expectations are not keyed off of your personal inflation rate, but rather a broad average. As most industry professionals look to CPI as a gauge of general inflation, it is quite reasonable to assume that yields on domestic bonds incorporate compensation for future expected inflation as measured by CPI. In that sense, there is little difference between buying TIPS which is formulaically tied to CPI and ordinary bonds which are loosely tied to CPI via market expectations. In either case, bonds do not compensate you for your personal inflation rate.

To the extent that TIPS and Treasuries have similar performance characteristics over the past several years only says that market expectations for inflation have been relatively accurate over that time period. That seems reasonable given the relatively low and stable level of inflation recently. However, the reason to own TIPS as part of a bond portfolio is that market expectations for future inflation can be wrong. And given the relatively low level of recent inflation (~4% +/-), there is greater risk that market expectations will err on the low side, rather than the high side . . . to your detriment as an ordinary bond holder. By diversifying a bond portfolio with TIPS, you become somewhat indifferent to whether the market is right or wrong with respect to inflation expectations.