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vanguard tips mutual fund
Old 10-16-2010, 01:14 PM   #1
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vanguard tips mutual fund

i have a question i about the vanguard tips fund not the actual tips securities. since bond fund navs go down when bond rates go up wouldn't it make sense to wait for inflation to be high before buying the tips fund? it seems like a no brainer - when inflation is high the tips fund will have a better yield and you can buy them at a lower price. it seems too obvious but isn't this just the exact time to buy them when the yield is high and the price is low? it seems so obvious that i question if i am missing something? presently i don't have any tips.

thank you,

v
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Old 10-16-2010, 01:51 PM   #2
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Hey v,

Welcome here.

I have VG TIPS fund as part of my retirement stash. It represents about 50% of my fixed income complement. My long term thinking is that I do not know exactly when inflation will occur, but I know that it will fluctuate and I wanted to have that diversification in my mix. So, I have it in my asset allocation and it has done what I thought it should have done.
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Old 10-16-2010, 03:37 PM   #3
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Quote:
Originally Posted by veremchuka View Post
i have a question i about the vanguard tips fund not the actual tips securities. since bond fund navs go down when bond rates go up wouldn't it make sense to wait for inflation to be high before buying the tips fund? it seems like a no brainer - when inflation is high the tips fund will have a better yield and you can buy them at a lower price. it seems too obvious but isn't this just the exact time to buy them when the yield is high and the price is low? it seems so obvious that i question if i am missing something? presently i don't have any tips.

thank you,

v


TIPS prices move inversely with real yields, not nominal yields. So it is possible to have high inflation and very high TIPS prices at the same time because everyone is trying to buy inflation protection, pushing down real yields, even as nominal yields soar. You see a bit of that in the market place today. The Fed has indicated it wants higher inflation and TIPS prices have rallied in response.
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Old 10-16-2010, 03:43 PM   #4
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TIPS are some of the most complex securities I own, but this is my thinking on this:

Because there is no inflation risk with TIPS, I don't think they will sell at a deep discount when inflation hits.

Let's say you buy a 1.5% 30-year TIPS and a 3.5% 30-year nominal treasury bond right now. In a few years, inflation rises to 10%.

Clearly, the 3.5% 30-year nominal treasury bond will start generating huge negative annual real returns with possibly a risk of negative real return even if held to maturity. Therefore the value of such bond will have to be deeply discounted by the market because of the huge inflation risk they carry.

TIPS, on the other hand, carry no inflation risk. They are guaranteed to generate a positive return over their lifetime, no matter how high inflation gets. In other words, TIPS holders have the option to hold TIPS to maturity while enjoying the inflation-adjusted income generated and recoup their inflation-adjusted principal at the end. So why would they run for the exits and sell at a deep discount when inflation hits? Actually, as an individual TIPS holder, there is no way I would sell my TIPS if inflation was at 10% and rising unless someone paid me a considerable premium for them.

Look at what the VG TIPS fund has done in the past. I bought it very cheaply in November 2008 when inflation was the least of people's worries. Low inflation expectation = cheap fund. Since then, inflation expectations have ramped up, and the fund has returned over 20% while inflation remained tame. High inflation expectation = expensive fund. If inflation starts picking up, inflation expectations will remain high for a while and the fund should continue to do well. When it becomes clear that inflation can been brought under control, then inflation expectations will diminish and the fund will become cheaper again. However, it will most likely become cheaper after the inflation has done its damage.
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Old 10-16-2010, 04:29 PM   #5
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Diversify!
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Old 10-16-2010, 09:44 PM   #6
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Quote:
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Low inflation expectation = cheap fund. Since then, inflation expectations have ramped up, and the fund has returned over 20% while inflation remained tame. High inflation expectation = expensive fund.
see this is the thing that i referred to, i meant to say if the demand for tips is high then shouldn't the price rise even tho inflation is rising thereby causing the yield to rise but i forgot to add that. this is atypical for a bond fund but it is what i would think would be the behavior of yield and nav in a rising inflation environment.

so now l have another question. in the tips fund there are many bonds and the average maturity is 9.3 years. wouldn't it take years for the older bonds to mature and new higher yielding bonds to replace them? so wouldn't the yield lag in the fund waiting for the low yielding bonds to mature or would they be sold and replaced with current tips with higher yields? if so (lower tips yields causing the funds yield to be low) would waiting to buy be better than buying now despite the nav would have risen assuming you plan to hold the shares and are not real concerned with nav changes? but the price you pay years from now may be a lot more than today so....

i find tips the most confusing investment, bonds in general are hard to figure tho i think i have a fair idea about them but tips are just so confusing it's why i have not exchanged some of my roll over ira into them.

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