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Re: TIPS for Dummies
Old 10-16-2006, 08:54 PM   #21
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Re: TIPS for Dummies

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Originally Posted by JohnEyles
So to do this you'd probably want to purchase your TIPS on the secondary market, since the auctioned ones have such a limited set of terms (5, 10, 20 years), right ?
Right, you can use a combination of new issues and secondary offerings to build your ladder. I tend to use nominal CD's for the "lower" rungs of the ladder since I'm less concerned about short-term inflation than long-term inflation.

Quote:
my brain finds the secondary market ones even more confusing
I didn't sense any confusion in your details -- you seem to have the secondary market figured out. Focus on the real YTM to make your purchase decisions. As an extra bonus, you can get higher coupons on the secondary market which means you'll get more inflation-adjusted income (and less "phantom" inflation-adjusted principal). And you also get to write-off a capital loss at maturity since you're paying over par.
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Re: TIPS for Dummies
Old 10-16-2006, 09:06 PM   #22
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Re: TIPS for Dummies

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Originally Posted by wab
Focus on the real YTM to make your purchase decisions.
That's the main statistic I didn't understand. It was 2.607% for my example.
What does it mean and how is it computed ?

Quote:
As an extra bonus, you can get higher coupons on the secondary market which means you'll get more inflation-adjusted income (and less "phantom" inflation-adjusted principal). And you also get to write-off a capital loss at maturity since you're paying over par.
So this would be viable in a taxable account, unlike the new issue, which is probably
a bad idea in the taxable account. But can you help us to understand how it is that
by buying one with a high coupon value that the phantom interest (for a given year)
is less than the principal times that year's inflation ?
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Re: TIPS for Dummies
Old 10-16-2006, 09:22 PM   #23
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Re: TIPS for Dummies

Quote:
Originally Posted by JohnEyles
That's the main statistic I didn't understand. It was 2.607% for my example.
What does it mean and how is it computed ?
You're paying 102.7 for a bond with a 3.77% coupon, which brings the real YTM to the market yield of 2.6% (for which you would pay closer to 100 on a new issue). 2.6% real sounds pretty good to me for a 2-year bond since inflation has been in the 4%+ range recently. You'll break even vs a nominal CD if inflation stays above 2.5% or so.

Yield to Maturity

Quote:
So this would be viable in a taxable account, unlike the new issue, which is probably a bad idea in the taxable account. But can you help us to understand how it is that by buying one with a high coupon value that the phantom interest (for a given year) is less than the principal times that year's inflation ?
Personally, I think the taxable vs tax-deferred deal is an overplayed bugaboo. I'm able to keep my marginal tax rate pretty low in retirement even with a fairly large income (thanks to low earned income, high deductions, and the ability to tax-manage most of my income). Another way to think of the "phantom" TIPS income is as reinvested interest, just like a CD (except the TIPS interest is state-tax free).

But basically you're paying more upfront for a higher coupon on the secondary market, so you'll get more income from the coupon payments and less on the back-end principal payment at maturity compared to a new issue.
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Re: TIPS for Dummies
Old 10-19-2006, 07:36 AM   #24
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Re: TIPS for Dummies

If tips are paying 2.5% over inflation, how can you safely withdraw 4%.
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Re: TIPS for Dummies
Old 10-19-2006, 10:57 AM   #25
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Re: TIPS for Dummies

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Originally Posted by bobbee25
If tips are paying 2.5% over inflation, how can you safely withdraw 4%.
You can't, if you are immortal.
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Re: TIPS for Dummies
Old 10-19-2006, 12:43 PM   #26
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Re: TIPS for Dummies

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Originally Posted by bobbee25
If tips are paying 2.5% over inflation, how can you safely withdraw 4%.
You can't, if you want your 4% income to last forever - that is, as Ha so eloquently
states, you are immortal.

Since most of us can safely assume that we have at most 30, 40, or 50 years left
on this earth, we can safely take a "return of principal" (I THINK am using this
term correctly), so the 4% consists of the 2.5% above inflation PLUS some of
the principal. You can easily create a simple spreadsheet (assuming you're
half-competent with Excel) and prove this to yourself. I have attached a
PDF from mine; I also tried to attach the XLS file itself, but it will not accept
that attachment.

Attached Files
File Type: pdf basic_withdrawl.pdf (14.7 KB, 21 views)
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Re: TIPS for Dummies
Old 10-19-2006, 12:54 PM   #27
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Re: TIPS for Dummies

Thanks for sharing JohnEyles, it's interesting that the principal amount increases till about the year 2021, although in that year it's not worth as much due to inflation. At least is was moving in the right direction.
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Re: TIPS for Dummies
Old 10-19-2006, 12:56 PM   #28
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Re: TIPS for Dummies

Quote:
Originally Posted by JohnEyles
Since most of us can safely assume that we have at most 30, 40, or 50 years left
on this earth, we can safely take a "return of principal" (I THINK am using this
term correctly), so the 4% consists of the 2.5% above inflation PLUS some of
the principal. You can easily create a simple spreadsheet (assuming you're
half-competent with Excel) and prove this to yourself. I have attached a
PDF from mine; I also tried to attach the XLS file itself, but it will not accept
that attachment.
Since you appear to be a novice, I will explain further - at least partly to clarify
the thoughts in my own head.

If you look at my spreadsheet, you will see that with an inflation-adjusted
withdrawal of 4% of initial portfolio value ($40K from $1M), your money will
last 40 years if you can get a return of just 5.5% and inflation is 3% - and
you will get similar results if you plug in other scenarios where ROR is 2.5%
above inflation.

Obviously this is extremely encouraging, and unfortunately very deceiving.
It only works this way if ROR and inflation are constant from year to year,
but they are not. Even if the AVERAGE inflation and ROR are 3% and 5.5%
over your time horizon, things will not work out nearly so rosily if there is a
lot of deviation from this average from year to year AND the disadvantageous
deviations (high inflation and/or bad or negative ROR) occur early in your time
horizon. You could also model this with a somewhat more complicated
spreadsheet, one that has separate ROR and inflation percentages for EACH
year - but I'm willing to take it on faith !

And modeling what happens in real-life (based on what HAS happened in real
life over the past century or so) is the whole point of FIRECalc.

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Re: TIPS for Dummies
Old 10-21-2006, 06:17 PM   #29
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Re: TIPS for Dummies

in the pdf, what formula are you using. Maybe I am not thinking clear tonight.
i.e. 4% of 4000 = 4160 ..... 4% of 101,390 = 4055
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Re: TIPS for Dummies
Old 10-21-2006, 10:00 PM   #30
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Re: TIPS for Dummies

Quote:
Originally Posted by bobbee25
in the pdf, what formula are you using. Maybe I am not thinking clear tonight.
i.e. 4% of 4000 = 4160 ..... 4% of 101,390 = 4055
The usual meaning of "safe withdrawl rate" is that if SWR = 4%, it means
that in the first year of retirement (2007 in my example) you take 4% of your
initial portfolio value. That is, you take 4% of $100,000 = $4000 in the first year,
2007. Then you increase that value by inflation (3% in my example) each year,
regardless of what the portfolio value is in the subsequent years. So in year 2008,
$4120 is $4000 inflated by 3%; the $4120 is not related to the portfolio value
in 2008.
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