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billystu 12-12-2004 04:56 AM

Hold TIPS in a fund or buy them direct???
 
I'm a complete novice when it comes to buying TIPS (and bonds in general actually).

I purchased some shares of Vanguard's inflation protected securities fund recently for my IRA, but I'm wondering if I should have bought the bonds directly from the Treasury. The average duration of the bonds in the TIPS fund is about 7 years if remember correctly.

What does everyone else here do?

billystu

billystu 12-12-2004 05:04 AM

Re: Hold TIPS in a fund or buy them direct???
 
Actually I was wrong about the average maturity-- it is 7 to 20 years. Is that too long in this rising interest rate environment, or does it matter with TIPS?

Another thing that worries me about the fund is this (from the Vanguard site):

"Up to 20% of the fund's assets may be invested in holdings that are not inflation-indexed. The fund will make such investments primarily when inflation-indexed bonds are less attractive. The fund's non-inflation-indexed holdings may include the following:

Corporate debt obligations.
U.S. government and agency bonds.
Cash investments.
Futures, options, and other derivatives"

Should I assume the fund managers know what they are doing won't blow themselves up? I've had stock funds that have blown up before, so that's why I ask :'(

Can you buy TIPs directly in an IRA account??

billystu

John Galt 12-12-2004 05:05 AM

Re: Hold TIPS in a fund or buy them direct???
 
Hello Billy..........no advice on TIPS, although obviously
they are very popular with the ER crowd.

I am a contrarian bond-wise and many here think I am going to get clobbered. Time will tell. Most of my
stash is in long term bonds, including some junk. Very
little is inflation protected, and of course there is a default risk. Now, if interest rates skyrocket and bond
NAV plummets, I would be unhappy. But, I thought
long and hard about the downside going in and this
board has been super. I still chose to go my own way
which is pretty typical.

JG

Richard Poole 12-12-2004 05:14 AM

Re: Hold TIPS in a fund or buy them direct???
 
Greetings-

I do both due to limited 401K options, but if I had my choice I would only buy at treasury auction. The reason: lower cost and the opportunity to match maturities with future needs.

Cost- I can buy at treasury auction online through Fidelity, and the fee is zero. That's right, nothing, zip, nada.

Maturity matching: If you are within 20 years of retirement (or in retirement), you can buy 5, 10 or 20 year TIPS in a ladder, with TIPS maturing each year. My portfolio is essentially index equity funds and TIPS, and the plan is that each year in retirement I will have the option of either rolling over a maturing bond, or taking it as income. The goal is to have income from maturing bonds available in years when the stock market performs poorly.

Cheers,
RP


billystu 12-12-2004 05:26 AM

Re: Hold TIPS in a fund or buy them direct???
 
" Lay investors may be befuddled by the technical implications outlined above and simply content themselves with owning a TIPS fund – again with recognition of the inherent risks of anyone or any firm being right all of the time. It cannot be done. The funds they own, however, should be managed by professional investors willing to prioritize their own most certain ideas and to draw investment conclusions from them. Aside from the near inevitability of Bush yielding to if not Kerry then Hillary in future months and years, low real short rates are my current best bet. And one of PIMCO’s new strategic bets based on this hypothesis is to own intermediate TIPS with real yields higher than ½%."

This is a quote from Bill Gross on TIPS, and I'm one of the lay investors who is befuddled. The fund "style box" thingy on my Vanguard TIPS fund says the average weighted maturity is medium, so I guess I'm OK there.

Here's the link to the Bill Gross article if anyone is interested. Maybe some of you bond experts can comment on his analysis and poke holes in it, because I don't understand much of his technical discussion.

http://www.pimco.com/LeftNav/Late+Br.../IO_Nov_04.htm

billystu

Richard Poole 12-12-2004 06:03 AM

Re: Hold TIPS in a fund or buy them direct???
 
" The funds they own, however, should be managed by professional investors willing to prioritize their own most certain ideas and to draw investment conclusions from them."

Bill Gross is a smart guy, but some of the self serving crap he publishes makes me want to throw up. Some of his insights are real, but I am convinced that a significant percentage is specifically designed to baffle the unwashed masses. Bogle he ain't.

RP

Peter 12-12-2004 01:23 PM

Re: Hold TIPS in a fund or buy them direct???
 
Quote:


Can you buy TIPs directly in an IRA account??

I don't think anyone answered this one directly -- yes, you can. My various IRAs are full of TIPS and nothing else. This is through Fidelity.

Most of them were bought at auction, which is my preferred method. Don't see why I should pay even a small management fee!

Peter




Cut-Throat 12-12-2004 01:51 PM

Re: Hold TIPS in a fund or buy them direct???
 
I currently hold the Vanguard TIPS fund in both my Wifes and my IRA Account, and I know that there are advantages for buying them direct.

Can anyone here lay out their 'ladder strategy' for buying TIPS direct?

Obviously I want the highest return and will not need any of this money for at least 10 years. What would the TIPS experts do? ???

Bob_Smith 12-12-2004 04:36 PM

Re: Hold TIPS in a fund or buy them direct???
 
TIPS mutual funds don't work well for me. These are the reasons I prefer long term TIPS purchased on the secondary market:

---I was able to lock in a real rate (2.54%) for a longer period of time (~25 years). I just prefer to have one portion of my portfolio that is as risk free as possible, for as long as possible.

---Bonds have had decades long stretches with negative real returns, so I prefer to lock in a half-way decent real rate for 25 years and eliminate that as something else hanging over my head. If real rates rise, I'll wish I had waited, but they may never rise above 2.5% in my lifetime. With a fund I'm exposed to whatever real rates the market dishes out in the years to come. Actually, I think I could make it on a 2.5% real return.

---With a fund I'm exposed to market risk, management risk, and annual expenses. With individual TIPS I can avoid market risk by holding to maturity, a manager can't mess up and leave me holding the bag, and I have a one-time nominal brokerage fee, instead of an annual percentage bite out of my assets.

---If I buy on the secondary market I can get bonds that yield 3.875%. Even though the yield to maturity on my TIPS is 2.54%, I will actually receive ~3.2% (real) in income relative to my initial investment. I'd rather receive more income annually and commensurately less in the end. It will enable me avoid selling bonds as I go.

The major risks I run are these:

---Deflation. I'm guaranteed to get the original auction price of the bond at maturity, not what I paid. Nevertheless, I'd still get my inflation adjusted income for 25 years - even in a deflationary scenario. Actually, I'm more concerned about inflation going forward.

---CPI manipulation. This is probably going on to some extent, but I think it's a relatively small risk compared to the risks I'd face elsewhere.

---I run the risk that real rates will rise. But that won't hurt me if I hold to maturity, which I plan to do. If real rates rise above 2.5%, my net worth would decline on paper, but my inflation adjusted income would continue as always, and I get the initial investment back at maturity, regardless of the market price at that time.

Anyway, this is just another viewpoint. With all my particulars, long term TIPS on the secondary market work well.

billystu 12-12-2004 07:17 PM

Re: Hold TIPS in a fund or buy them direct???
 
Bob Smith,

Thanks for the TIPS tips!

I just looked at the real rate of my Vanguard inflation fund, and it is only 1.24%.

How are you getting a real rate of 2.54? Are you going out longer on the maturities than my fund?

Are you able to get that 3.875% yield on the secondary market because you are buying them below par?

billystu

Bob_Smith 12-12-2004 07:29 PM

Re: Hold TIPS in a fund or buy them direct???
 
Billystu, yes, I own 30 year TIPS that mature in roughly 25 years. I purchased them on the secondary market when the yield to maturity was 2.54%. That was about 7-8 months ago. While the yield on the bonds I bought was 3.875%, the yield to maturity at the price I paid was 2.54%.

krane 12-12-2004 10:44 PM

isisRe: Hold TIPS in a fund or buy them direct???
 
My understanding is that TIPS funds and ETFs continuously pay out the inflation increase part of the capital of the bond at the time of paying out the normal dividend. This is contrary to holding TIPS direct where the inflation increase part of the capital is only paid out to the holder when the bond matures.

Not sure whether that would make a difference over a period of years if holding a TIPS fund? Presumably if inflation went to, say, 10% then dividends would increase substantially.

I don't hold either funds or individual TIPS but I'm thinking about it.

Richard Poole 12-13-2004 02:30 AM

Re: Hold TIPS in a fund or buy them direct???
 
Hi-

"Can anyone here lay out their 'ladder strategy' for buying TIPS direct?"

I don't know much about buyingTreasury Direct but you can buy at auction through your broker. It should be cheap or free (low or no fees, and no spread).

If you buy a 10 year and a 20 year TIP each year for the next 10 years, you will have a 20 year ladder that has a bond maturing each year. Or you can build a 10 year ladder in 5 years by buying 5's and 10's.

RP

Richard Poole 12-13-2004 02:32 AM

Re: Hold TIPS in a fund or buy them direct???
 
Hi-

"Can anyone here lay out their 'ladder strategy' for buying TIPS direct?"

I don't know much about buyingTreasury Direct but you can buy at auction through your broker. It should be cheap or free (low or no fees, and no spread).

If you buy a 10 year and a 20 year TIP each year for the next 10 years, you will have a 20 year ladder that has a bond maturing each year. Or you can build a 10 year ladder in 5 years by buying 5's and 10's.

RP

Roger_R 12-13-2004 06:57 PM

Re: Hold TIPS in a fund or buy them direct???
 
Bob wrote,
Quote:

I was able to lock in a real rate (2.54%) for a longer period of time (~25 years). I just prefer to have one portion of my portfolio that is as risk free as possible, for as long as possible
Bob, I'm hardly the bond expert but as I would understand bond purchases on the secondary market, you would pay a premium for bonds paying higher than the prevailing rate. And that the premium would be adjusted so that you essentially would earn close to the current rate? I can see the advantage of the long term horizon, but other than that are there advantages in return realtive to new issues?

I'm still studying up on the differences between buying out right vs. a fund, but I'm thinking that a more laddered approach, perhaps weighted to the long end of things might be a personal preference. In which case you could have both a fund that essentially "ladders" the maturities, as well as some longer term bonds that would assure long term and predicable returns.

Though if the real rate would bump up a bit it would be awefully temping dive in pretty strongly and put much of the second guessing or worrying about market fluctuations behind.


Bob_Smith 12-13-2004 10:20 PM

Re: Hold TIPS in a fund or buy them direct???
 
Quote:

...other than that are there advantages in return realtive to new issues?
Roger, I can think of only two reasons to buy on the secondary market:

1) To get maturities longer than 20 years. When I bought the longest I could get was 10 years. So at the time I really had no choice if I wanted to lock in for a long time.

2) To get the higher coupons on the older bonds, which means more income over the life of the bond - but less back in the end. This was something that I preferred to have. Getting 3.2% instead of 2.5% was enough to make a difference for me. It eliminated the need to sell as I go in order to meet my income needs. I don't think this is a major consideration, but it could be real a plus for some - it was for me.

I can't think of any other reasons to buy on the secondary market. If it weren't for these two things, I would have used Treasury Direct. Treasury Direct is better if these two issues don't matter to you, IMO.

I also think I-Bonds are better than TIPS for the shorter maturities.

EDITED: One more small advantage to buying on the secondary market: you know what you're getting when you buy. Prices can change a little, just in the time it takes you to submit the brokerage order, but you can get very close. When you buy at auction you must estimate what you'll get based on current secondary market rates.


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