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Understanding TIPS
Old 07-27-2017, 10:06 AM   #1
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Understanding TIPS

Per advice I have for some time kept about 10% TIPS. I can't seem to figure out if it is making money ?.....I thought they were going to keep up with inflation, so I would guess about 2%.

SCHP
total return one year -.77
three year .57
five year .16

distribution yield 1.79%
30DAY SEC yield 3.62

This does not add up. My only guess is "total return" does not include distributions.

Please explain.

Thanks
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Old 07-27-2017, 12:20 PM   #2
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Total return for a TIPS fund = coupon + inflation adjustment - expenses + change in market price

SCHP has a relatively long duration so it will be sensitive to interest rate changes.
As interest rates rise, the market value will fall. This change has (nearly) cancelled out the coupon and inflation adjustment, so the total return has been small.

If you want a fund with less sensitivity to interest rate changes, get one with a shorter duration: 'short term', but the coupon will be less also.
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Old 07-27-2017, 01:51 PM   #3
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I can dimly understand a diversification argument for buying corporate and international bond funds. I can see no argument for buying TIPS in a fund.

Buy 'em over the counter or in the auctions. Collect the coupon interest rate on the inflation-adjusted bond value until maturity, then collect the inflation-adjusted face value. No risk. No muss, and the only fuss is paying taxes on the annual inflation increases without actually receiving the cash. And that is only an issue in a taxable account.

Diversification is unnecessary unless you are the tinfoil hat sort of person. The yield curve is so flat that fancy laddering is unnecessary unless you need cash to support annual spending. So little angst is required there either.

IMO, anyway. YMMV.
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Old 07-27-2017, 01:56 PM   #4
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Quote:
Originally Posted by ducky911 View Post
Per advice I have for some time kept about 10% TIPS. I can't seem to figure out if it is making money ?.....I thought they were going to keep up with inflation, so I would guess about 2%.

SCHP
total return one year -.77
three year .57
five year .16

distribution yield 1.79%
30DAY SEC yield 3.62

This does not add up. My only guess is "total return" does not include distributions.

Please explain.

Thanks
TIPS pay a fixed coupon rate. When the bond matures, the principal is paid along with any inflation adjustment.
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Old 07-27-2017, 08:33 PM   #5
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Originally Posted by OldShooter View Post
I can dimly understand a diversification argument for buying corporate and international bond funds. I can see no argument for buying TIPS in a fund.

Buy 'em over the counter or in the auctions. Collect the coupon interest rate on the inflation-adjusted bond value until maturity, then collect the inflation-adjusted face value. No risk. No muss, and the only fuss is paying taxes on the annual inflation increases without actually receiving the cash. And that is only an issue in a taxable account.

Diversification is unnecessary unless you are the tinfoil hat sort of person. The yield curve is so flat that fancy laddering is unnecessary unless you need cash to support annual spending. So little angst is required there either.

IMO, anyway. YMMV.
I thought a fund would make it simpler to take out random amounts at random times.

Maybe someone with experience in both buying and selling TIPS on a semi-regular basis could provide some insights (you might be that person).
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Old 07-28-2017, 09:27 AM   #6
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Originally Posted by Independent View Post
... random amounts at random times. ...
buying and selling TIPS on a semi-regular basis ...
Well, I'll start with the disclaimer that advice you get on the internet may well be worth exactly what you paid for it.

To me, long term assets are held for the long term. Equities, for example, are not held with a two or three year time horizon. Similarly, bonds are bought and expected to be held to maturity.

I don't know what kind of trading frequency you are thinking of here, but inflation is a long-term thing, usually fairly slow moving. So over the short term, the inflation protection that TIPS offer gets you almost nothing.

For the short term (1-3 years or 1-5 years) I buy short-term assets. For example we just had a couple of 3-year brokered CDs coming due. One this week and one next week. Both chunks of money are going into 3-month treasury bills. The first batch we bought over the counter, YTM of 1.17%. I could have had a 3-month brokered CD at 1.2% but 3bps is hardly the price of a good dinner and the bills are easy to trade if I decide on a better home for the money. The second CD pays out about the time of the month-end treasury auction so we are buying treasury bills that way. We also have a bunch of cash in a floating-rate fund, SAMBX, that has been paying around 3% IIRC. A little more risk, a little more reward.

So if you want to trade TIPS and try to make some money, I can't suggest how to do it and I'm pretty sure it will be losing endeavor anyway. If you are buying and selling to manage a cash flow, then my tactic would be short term stuff like money markets, t-bills, and t-notes. A short-term treasury fund would work, too, but for us these transactions are well into six figures and I'd rather avoid paying someone to do a stupid-simple task, buying govvies, I can do myself.
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Old 07-28-2017, 10:55 AM   #7
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Originally Posted by MichaelB View Post
TIPS pay a fixed coupon rate. When the bond matures, the principal is paid along with any inflation adjustment.
Correct. Fixed rate. But it's important IMO to understand that the interest payment is based on the coupon rate applied to the inflation-adjusted value of the bond. So those are inflation-adjusted dollars, too. Quite nice, actually.
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Old 07-28-2017, 12:24 PM   #8
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Originally Posted by OldShooter View Post
Well, I'll start with the disclaimer that advice you get on the internet may well be worth exactly what you paid for it.

To me, long term assets are held for the long term. Equities, for example, are not held with a two or three year time horizon. Similarly, bonds are bought and expected to be held to maturity.

I don't know what kind of trading frequency you are thinking of here, but inflation is a long-term thing, usually fairly slow moving. So over the short term, the inflation protection that TIPS offer gets you almost nothing.

For the short term (1-3 years or 1-5 years) I buy short-term assets. For example we just had a couple of 3-year brokered CDs coming due. One this week and one next week. Both chunks of money are going into 3-month treasury bills. The first batch we bought over the counter, YTM of 1.17%. I could have had a 3-month brokered CD at 1.2% but 3bps is hardly the price of a good dinner and the bills are easy to trade if I decide on a better home for the money. The second CD pays out about the time of the month-end treasury auction so we are buying treasury bills that way. We also have a bunch of cash in a floating-rate fund, SAMBX, that has been paying around 3% IIRC. A little more risk, a little more reward.

So if you want to trade TIPS and try to make some money, I can't suggest how to do it and I'm pretty sure it will be losing endeavor anyway. If you are buying and selling to manage a cash flow, then my tactic would be short term stuff like money markets, t-bills, and t-notes. A short-term treasury fund would work, too, but for us these transactions are well into six figures and I'd rather avoid paying someone to do a stupid-simple task, buying govvies, I can do myself.
Thanks. I think the issue may be the confidence in when we might want the money. I don't know if I feel I come out ahead by trying to schedule maturities around unknown cash flow needs, vs. taking the market risk on funds. My guess is that it comes down to a few basis points either way.

There's also the issue of just plain comfort level in setting up the brokerage account, placing buy and sell orders, thinking about bid-ask spread, or whatever.

I had some CDs when I retired, but mostly funds because that was the option in the 401k. I rolled the 401k into Vanguard funds and burned the CDs. We're coming up on RMDs, and that money will need to be reinvested. I'm thinking I should/could look at other options for it.
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Old 07-28-2017, 12:41 PM   #9
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Old 07-28-2017, 12:49 PM   #10
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... I don't know if I feel I come out ahead by trying to schedule maturities around unknown cash flow needs ...
My favorite model for that is "buckets." First, a bucket of money that is sufficient to cover what I expect to need for the next three years (at least). This bucket is invested in short term stuff that I can turn to cash easily. Second, a long term bucket that is in bonds, equities, etc. If sailing is fairly smooth, annually move a year's worth of needs from the long bucket to the immediate bucket. If things are exciting, like a 20% market drop, suspend moving for a year or two or three until the long bucket has recovered. With that approach, you really don't have to worry about maturities except maybe to keep some casual control between bills and notes in the short bucket. In the long bucket, maturities happen when they happen and the funds just get reinvested or maybe some of the money is used in immediate bucket replenishment. But you can lose real money in bond funds where buying and holding bonds to maturity you get exactly what you expect to get, no more and no less.

Some people argue for a third, intermediate, bucket. Too complicated for me!

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Originally Posted by Independent View Post
We're coming up on RMDs, and that money will need to be reinvested. I'm thinking I should/could look at other options for it.
Yup. We are in the same boat. Basically we'll just continue to execute our AA plan but will manage the investments however looks to be the best from a tax standpoint. Generally, passive equities in the taxable account to take advantage of capital gains rates. But I don't see that the AA changes.
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