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Re: Vanguard TIPS fund...
Old 08-05-2006, 06:34 PM   #61
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by BUM
The more I read the confuseder I get. I bought VIPSX

1/05* 4000 @ 12.50
1/06* * 800 @ 12.21
5/06* * 550 @ 11.80

I started reinvesting the dividends in January '06.

Arithmatically speaking should I be* * * * * or* * * * * * *?
Where's the shrug icon?

I know this is a difficult sell, but ignore the NAV fluctuations.* *Bond funds are primarily about income streams.* *Your income from the fund has actually increased over that period, which offsets some of the NAV hit.* *Over time, the increase in income will completely offset any NAV hit.

When you first invested in Jan 2005, the real component of TIPS was at 1.79%.

By May 2006, the real component had gone up to 2.45%.* *That's a 37% increase in rates!* *The value of those TIPS went down because nobody wants to pay the same price for the lower yielding bonds the fund owned in 2005.* *The price correction is automatic with the change in yield.

Here are my personal rules of thumb for TIPS.* *This is what I do:

1) I don't consider TIPS very attractive at real rates below 2.5%.* *The long-term historical real yield on treasuries is about 2.5%, so that's what I use for my TIPS benchmark.

2) I buy individual bonds rather than funds.* *I hold till maturity, and I don't have to pay any annual management expenses.

If you bought a TIPS fund in Jan 2005 when the real rate was 1.8%, and the average maturity of the fund was 10 years, then if you ignore NAV fluctuations over the next 10 years or so, you should be able to look back and say "look, I got pretty close to a 1.8% real annual return on my investment over than period."
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Re: Vanguard TIPS fund...
Old 08-06-2006, 02:10 AM   #62
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Re: Vanguard TIPS fund...

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Originally Posted by wab
The long-term historical real yield on treasuries is about 2.5%, so that's what I use for my TIPS benchmark.
I was poking around at historical bond data tonight (isn't that how everybody spends Saturday night?).* * Averages can be deceiving, so I wanted to look a bit closer at the data.

As I mentioned earlier, TIPS are designed to remove inflation risk from nominal bonds.* *If you buy a 10-year nominal treasury bond, in theory that bond is supposed to include the market's guess of inflation over the next 10 years + some real return + a risk premium in case the inflation guess is wrong.

So, how often has that guess been *way* off?* * Well, you don't really know until the bond matures at the end of the 10-year holding period.* *It turns out that you were burned pretty badly (total negative real return over the 10-year period) if your bond matured in any of these periods: 1916-1924, 1945-1955, 1973-1982.* *Basically, 30 years out of the last 130 years have been very unkind to nominal bond holders.* *That's about a 23% chance of being burned.* * And that's what TIPS will protect you against.

On the other hand, there are a few periods when nominal bonds have done very well.* *Anybody who bought a 10-year nominal in 1982, for example, made a killing (annualized return of 13% real) because the market so badly *overestimated* inflation over the next decade.* *So, TIPS will give up this sort of upside potential while they offer downside protection.

Bottom-line: buy TIPS at times when nominal rates are low and inflation risk is high (like now), and buy nominals once inflation drives nominal rates through the roof.
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Re: Vanguard TIPS fund...
Old 08-06-2006, 02:19 AM   #63
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by wab
. . .
Bottom-line: buy TIPS at times when nominal rates are low and inflation risk is high (like now), and buy nominals once inflation drives nominal rates through the roof.
wab, I always try to read your posts because you often have ensights and unique experience or analysis to share. But wasn't this one a little obvious?
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Re: Vanguard TIPS fund...
Old 08-06-2006, 02:23 AM   #64
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Re: Vanguard TIPS fund...

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Originally Posted by sgeeeee
But wasn't this one a little obvious?
Yeah, it seems obvious to me, but for some reason a lot of people shun TIPS and have no qualms with a huge allocation to nominal bonds. Making the obvious obvious ain't always easy.
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Re: Vanguard TIPS fund...
Old 08-06-2006, 05:35 AM   #65
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Re: Vanguard TIPS fund...

Got it, thanks wab. Sometimes the obvious escapes me.



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Re: Vanguard TIPS fund...
Old 08-06-2006, 06:48 AM   #66
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by wab
*Making the obvious obvious ain't always easy.*
Yeah you rite! - I seem to possess a mental block when it comes to bonds - having to sit down and relearn the nuts and bolts from time to time. I compensate/cop out by buying balanced index - the price being you've 'bought' the mission of the particular fund - aka Target Retirement 2015 being the latest - too young for my age - but even there I'm an optimist(overweighting stocks).

I suspect I could improve my ER income, takeout, SWR or whatever by 50 to 100 basis points by fine tuning 'MY' portfolio to 'MY' individual ER situation but I don't know that for sure.

Those pesky male hormones!

heh heh heh
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Re: Vanguard TIPS fund...
Old 08-06-2006, 07:10 AM   #67
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Re: Vanguard TIPS fund...

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Originally Posted by Cute Fuzzy Bunny
I guess we'll just keep talking about different time frames, eh?

Nevermind...you're right...crappy returns are good and its a great idea to buy and own lots of bonds in a rising rate environment

In the time I've owned it, the nav is down about 2500 net, and its paid out roughly $13,400 in dividends.

Really, really sucks.
Ha! And you're saying TIPS are a crappy investment while displaying your love for high yield bonds?

Let's comare

1. investment offers me a guaranteed real return backed by the best creditor the world has ever known.

2. Allows me to take all the risk of a stockholder, caps my return, and at best pays a paltry 200bps over comparable nominal treasuries?

Boy, where do I sign up for number 2??
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Re: Vanguard TIPS fund...
Old 08-06-2006, 08:05 AM   #68
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by wab

As I've said, I *think* this puts the upper bound on how long you need to hold a fund at 2 X duration before you're guaranteed the same total return you'd get by holding a bond.
Wab... I have decided to read the whole thread... and it seems CFB does not either understands, or does not want to understand...

BUT, I will have to disagree with you on this statement... the funds are buying and selling all the time.. and their duration changes... so if they are 'bad' at when to buy and when to sell, you can lose (or I guess gain).. no guarantee of being at the same total return... in other words... a dynamic vs a static portfolio...
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Re: Vanguard TIPS fund...
Old 08-06-2006, 09:03 AM   #69
 
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by wab
Here are my personal rules of thumb for TIPS. This is what I do:

1) I don't consider TIPS very attractive at real rates below 2.5%. The long-term historical real yield on treasuries is about 2.5%, so that's what I use for my TIPS benchmark.

2) I buy individual bonds rather than funds. I hold till maturity, and I don't have to pay any annual management expenses.
I have read a few articles about the advantages of buying a TIPS fund rather the individual bonds. I can't remember all the details, but it had to do with ease of selling the fund vs. the individual (bank or broker) - The article actually detailed how an investor could make a higher return with a Fund. But I doubt if I could repeat it accurately.

Also: Can you see any reason for holding a Vanguard TIPS index fund AND a Vanguard Short Term Treasury Bond Index Fund?
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Re: Vanguard TIPS fund...
Old 08-06-2006, 10:42 AM   #70
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Re: Vanguard TIPS fund...

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Originally Posted by Texas Proud
I will have to disagree with you on this statement...* the funds are buying and selling all the time.. and their duration changes... so if they are 'bad' at when to buy and when to sell, you can lose (or I guess gain)..* no guarantee of being at the same total return...* in other words... a dynamic vs a static portfolio...
You're absolutely right.* *The fund picture can be a lot more complicated than I've presented, but if you make some simplifying assumptions (that the fund owns a large number of bonds and they attempt to maintain average duration), then what I've said about bond funds should be true.* *In the case of Vanguard, I believe these are safe assumptions.

Since funds and interest rates environments make the "calculation" complex, I've looked everywhere for a bond fund (or bond portfolio) simulator, but no luck so far.* *I'm feeling the itch to build a simulator, but I'm hoping the feeling will pass.

Quote:
Originally Posted by Cut-Throat
I have read a few articles about the advantages of buying a TIPS fund rather the individual bonds. I can't remember all the details, but it had to do with ease of selling the fund vs. the individual (bank or broker) - The article actually detailed how an investor could make a higher return with a Fund. But I doubt if I could repeat it accurately.
A fund has certain advantages (if you need them): it's more liquid, no buy/sell commissions or spreads, and in the case of TIPS, they pay out the inflation adjustment as a dividend.

Good fund managers also have a bunch of tricks available to them to juice yields (like riding the yield curve).

Quote:
Also: Can you see any reason for holding a Vanguard TIPS index fund AND a Vanguard Short Term Treasury Bond Index Fund?
Sure -- they're completely different animals.* *The NAV of a short-term bond fund will be less sensitive to rate changes (shorter duration) and will be more sensitive to the shorter end of the curve (driven by the fed).* *The historical real return of short-term funds is closer to 1%, so you're basically giving up a 1.5% "term premium" for staying with short duration.* *Also, as we've seen recently, the fed sometimes will drive rates so low that short-term bonds have a *negative* real return.* *Short-term bond funds are basically a proxy for cash with a slightly higher yield than money market accounts.
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Re: Vanguard TIPS fund...
Old 08-06-2006, 12:30 PM   #71
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Re: Vanguard TIPS fund...

How does the fund manage to pay out the inflation adjustment as a dividend? They don' t receive this payout from the bonds that are owned by the fund, correct?... thanks, bill
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Re: Vanguard TIPS fund...
Old 08-06-2006, 12:36 PM   #72
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Re: Vanguard TIPS fund...

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Originally Posted by WilliamG
How does the fund manage to pay out the inflation adjustment as a dividend?* They don' t receive this payout from the bonds that are owned by the fund, correct?... thanks, bill*
I don't think they pay out the inflation adjustment.* But the coupon on TIPS is paid on the adjusted principal balance of the bonds, so your coupon increases with inflation.* *

Example, $1,000 invested in a 2.5% yielding TIPS for three years with 3% inflation:

* * * * *Principal* *Coupon* *Coupon Growth
Year 1 1,000 25.0
Year 2 1,030 25.8* * * 3.00%
Year 3 1,061 26.5* * * 3.00%
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Re: Vanguard TIPS fund...
Old 08-06-2006, 12:40 PM   #73
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Re: Vanguard TIPS fund...

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Originally Posted by 3 Yrs to Go
I don't think they pay out the inflation adjustment.* But the coupon on TIPS is paid on the adjusted principal balance of the bonds, so your coupon increases with inflation.* *
We'll have to go through the dividend math again. I'm pretty sure they pay out the inflation adjustment as a dividend.

Think about it. If you ran a TIPS fund with an average maturity of 10 years, that means 10% of your bonds are maturing each year. I think TIPS are issued twice a year (January and July), so you are getting a 5% cash injection every 6 months. Vanguard probably figured it made a lot of sense to pay out the inflation adjustment from this cash.
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Re: Vanguard TIPS fund...
Old 08-06-2006, 12:47 PM   #74
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Re: Vanguard TIPS fund...

Thanks Wab. Makes sense. In essence they are running a super large ladder and and distributing the gains at maturity rather than re-investing (at least in part, am sure it's more complicated than that!).

Have thought some about buying TIPS directly rather than by fund, but this payout is one plus I like as well as the liquidity. Also don't particularly want to go out further than around 5 years on a ladder, which I do with a CD ladder in IRA.
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Re: Vanguard TIPS fund...
Old 08-06-2006, 12:51 PM   #75
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by Cut-Throat
I have read a few articles about the advantages of buying a TIPS fund rather the individual bonds. I can't remember all the details, but it had to do with ease of selling the fund vs. the individual (bank or broker) - The article actually detailed how an investor could make a higher return with a Fund. But I doubt if I could repeat it accurately.

Also: Can you see any reason for holding a Vanguard TIPS index fund AND a Vanguard Short Term Treasury Bond Index Fund?
Yes, I see a reason. I assume you mean duration of 2 years or so, and not a money market. Two reasons actually. The most important reason is that it is possible for the short term treasury index to deliver a negative or barely positive real return for quite some period of time. If the Fed is aggressively lowering short rates, it will ordinarily spill over into the 2-3 year horizon covered by short term funds. The same would be true of buying a money market fund. Should the Fed lower rates, you could have a negative real return with straight bonds or notes regardless of duration.

The second reason is more speculative, and positive for the 2-3 year maturity notes. Right now, these notes or bonds have YTMs almost identical with long term bonds. Should the Fed lower rates, they will have more affect at the near end of the maturity curve, so your 2 to 3 year note will be rolling down the maturity curve, and you could get a nice capital gain with very little or no risk. If short rates fall a fund should do as well as owning the notes directly. However, if rates should go higher instead, I believe the note is safer, since you are out at par in 2 years.

Ha
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Re: Vanguard TIPS fund...
Old 08-06-2006, 01:01 PM   #76
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Re: Vanguard TIPS fund...

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Originally Posted by HaHa
The second reason is more speculative, and positive for the 2-3 year maturity notes. Right now, these notes or bonds have YTMs almost identical with long term bonds. Should the Fed lower rates, they will have more affect at the near end of the maturity curve, so your 2 to 3 year note will be rolling down the maturity curve, and you could get a nice capital gain with very little or no risk. If short rates fall a fund should do as well as owning the notes directly. However, if rates should go higher instead, I believe the note is safer, since you are out at par in 2 years.
If rates fall, you'll get a short-term cap gain, but over the longer-term you'll get whatever the rate falls to.* *That's why Bill Gross thinks it's time to lengthen your maturity:

Pimco Commentary
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Re: Vanguard TIPS fund...
Old 08-06-2006, 01:21 PM   #77
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by wab
If rates fall, you'll get a short-term cap gain, but over the longer-term you'll get whatever the rate falls to.* *That's why Bill Gross thinks it's time to lengthen your maturity:

Pimco Commentary
You don't have to stay invested. Maturity is 2 to 3 years. You take your gain or your par and go on your way. Bill Gross is right about strategy, if he is right about rates. My strategy OTOH is a chicken spec- it likely will work out, but if not no real harm done. Of one thing I am absolutely sure- this particular guy is not making any long term loans at ( =< 5%), regardless of any expert's prediction about rates. Remember, we are all indexers and efficient marketeers- we don’t believe that these things are predictable.

Ha

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Re: Vanguard TIPS fund...
Old 08-06-2006, 05:51 PM   #78
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Re: Vanguard TIPS fund...

Quote:
Originally Posted by wab
Here's an explanation of duration, including the math:

Duration

Note that the duration tells you two things:

1) How sensitive the bond is to interest rate changes

2) When you'll get half the total return of the bond

As I've said, I *think* this puts the upper bound on how long you need to hold a fund at 2 X duration before you're guaranteed the same total return you'd get by holding a bond.

Anyway, I'm sure you'll agree that it's not an unbounded problem.* *You never have to wait forever.*
Unfortunately, you are never "guaranteed" that your total return (accumulated interest plus return of principle) will ever equal that of a fixed term bond or CD. A fund may have a better return... If you buy a fund before a longterm drop in interest rates may have you getting twice the market return after my poor old CD matures. Or the fund may have a worse return.... If interest rates go through the roof (remember 18%), you'll have to hold that fund until they fall again (assuming your saying "equal" means you are not comparing to my ability to role my principle into the higher interest rate).

I only use fixed income to produce a known quantity of cash on a given date. If you buy a fixed income fund you get the "interest" but you can never be assured that on a predetermined date in the future your principle will be a specific amount.

Individual bonds/CDs and fixed income funds are two different animals.
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Re: Vanguard TIPS fund...
Old 08-06-2006, 06:27 PM   #79
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Re: Vanguard TIPS fund...

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If you buy a fixed income fund you get the "interest" but you can never be assured that on a predetermined date in the future your principle will be a specific amount.
I never said that a fund would guarantee your principal would be returned at the end of some term.* *I said it was likely you'll get the same total return at the end of a long-enough term.

Let us both agree on your point: the fund's NAV will go down if interest rates go up.* *Now, let me see if I can get you to agree on the point I was making:

The fund's bonds will be continuously maturing.* *They will be replacing those matured bonds with new bonds.* *In an increasing interest rate environment, each new bond will be paying higher coupons than the bonds they replaced.* *The *income* of the fund will be going up (not just the yield).* *This is obviously different than the case of a bond owner with a single bond.* *He is stuck with the same income stream for the life of the bond (remember, I said let's ignore reinvested interest).

Do you see how the increase in *income* will offset the decline in principal over time?

Because there are so many variables (continuously varying interest rate environment, number of bonds, average maturity, duration, etc), I think it's impossible to calculate the break-even point.* * But I think it should be bounded by 2 x duration, and on average it'll be closer to the average maturity of the fund.

I would love to find a bond fund simulator to demonstrate this, but so far I've had no luck finding one.
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Re: Vanguard TIPS fund...
Old 08-07-2006, 05:26 PM   #80
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Re: Vanguard TIPS fund...

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Originally Posted by wab
Let us both agree on your point: the fund's NAV will go down if interest rates go up.* *Now, let me see if I can get you to agree on the point I was making:

The fund's bonds will be continuously maturing.* *They will be replacing those matured bonds with new bonds.* *
I don't agree because it's not true. A true bond fund (not a unit investment trust) targets a specific maturity range. Say a bond fund targets an 8 year maturity. They will typically buy 10 year bonds but them sell them with around 6 years left. When selling, they take either a capital gain or loss on the original purchase price of the bond. Gains would show up in the fund distribution if there weren't enough carry-forward losses to off-set them. Most bond funds carry a reasonable amount of losses forward so capital gains seldom show up. Individual investors also take gains or losses based on changes in NAV.

The bond funds don't carry bonds to maturity because of two reasons. First, they advertise themselves at a specific maturity ratio. Second, yields typically drop as bonds near maturity and the funds want to advertise as high an interest rate as possible to lure in customers.

The bottom line for funds is that you will continue to earn the same interest rate on the fund as when you bought it -- comparing it to your return on the original purchase price. It will drift some but very slowly as compared with the true interest rate changes.
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