How should I invest my savings?

[wabmester]

How do you explain the discrepancy between the
TIPS fund at 1.6% real and new issues of 10 year
TIPS at 2.02%?  You can blow off 0.18% due to the
expense ratio.  Is the rest due to the lag in SEC
calculation?  It would seem that an efficient market
would drive the NAV of the fund to compete with
new TIPS otherwise.

It's a mystery to me. The SEC Yield should be an average over the last 30 days less fees. The yield for the 10-year has been consistently over 2% for the last 30 days, so my only guess is that they took some capital losses over the last 30 days which pushed the yield down.

Market efficiency shouldn't have anything to do with the NAV of an open-ended bond fund like Vanguard's. I assume they just mark to market like any other bond holder would to calculate the NAV.

 

[cute fuzzy bunny]

Would it have anything to do with the fact that they're buying new and selling older bonds, and as they buy more newer bonds (lower yielding) to handle inflows the yield goes down?

 

[wabmester]

Year 1 inflation is -10% (i.e., deflation).   Year 2 inflation is 10%.   Net inflation for the 2-year period is 0%.

NO -- It's NOT!!! :

Yeah, you're right, that's not the way to calculate net inflation, but I was hoping that would explain the FIREcalc results.   It doesn't.

So, here's another guess:  FIREcalc pays you at the end of the year, but it doesn't do the inflation adjustment for your withdrawl until the following year.

I think the result of this logic is that deflation can cause FIREcalc to withdraw more than the amount that it thinks your TIPS are yielding.   So, the 2-year failure example looks  this:

Year-1 inflation = -10%, Year-2 = +10%

Year 1: start with $100K, apply inflation adjustment to give you $90K, withdraw $50K, leaving you with $40K

Year 2: apply inflation adjustment to principal giving you $44K, apply previous year's inflation to withdrawal making it $45K, which leaves you $1000 in the hole, and FIREcalc says TIPS failed you.

So, I guess the moral of the story is either that you shouldn't handle your money the way FIREcalc does, or that FIREcalc has a misfeature, or that I'm completely off base.

 

[wabmester]

Would it have anything to do with the fact that they're buying new and selling older bonds, and as they buy more newer bonds (lower yielding)  to handle inflows the yield goes down?

I don't think so. Selling an old bond and buying a new one shouldn't change your yield. The market prices the old one to match the current yield.

However, if you have a net outflow from a fund, then they may have to sell bonds at a loss, which does get reflected in the SEC Yield.

As far as I know, net inflow/outflow and changes to a fund's portfolio are pretty opaque, which is one of the reasons I avoid bond funds. Especially in the case of treasuries, since you can buy new issues with no fees or mark-up.

The only service Vanguard is providing for their VIPSX fee is increased liquidity over individual bonds, which doesn't provide much value if you plan to hold to maturity.

 

[Cut-Throat]

Year 1 inflation is -10% (i.e., deflation).   Year 2 inflation is 10%.   Net inflation for the 2-year period is 0%.

Year 1:  you have $90K after inflation adjustment and you withdraw $45K, leaving $45K

Wab,

If you start off with a 100K and have deflation of 10%, at the end of the first year you have 110K of purchasing power - Don't you? Correct me if I'm wrong

 

[MJ]

I know it's investment 101

but

what is NAV, I'm sure it's not Norton Anti-Virus.

I searched the site but did not find a definition.

Thanks

MJ

 

[bobbee25]

net asset value

 

[wabmester]

If you start off with a 100K and have deflation of 10%, at the end of the first year you have 110K  of purchasing power - Don't you? Correct me if I'm wrong

Not if you're invested in TIPS (and the example above is trying to explain FIREcalc's low success rate for TIPS).

TIPS are designed to maintain your purchasing power (plus a return on your investment), which means the government increases your principal in times of inflation and decreases it in times of deflation (but they give you a small bonus in that they won't decrease it below your original investment).

 

[cute fuzzy bunny]

Ok, I looked at vanguards tips portfolio in the prospectus, and I think the reason why the yield is low hit me.

They're holding all 3.xx and even some 4.25% tips.

So given that these are older, higher interest rate bonds, then wouldnt the NAV of the fund have gone up a lot as these bonds became worth more as interest rates have declined? Yo...look...the nav of the fund HAS gone up a lot! More than 25% in the last few years in lockstep with interest rate drops.

So when the nav of the fund goes up against the static interest rate, then technically the "yield", which is a function of interest rate to nav, goes down.

So in my mind that makes buying this fund a very bad idea. You're buying a highly inflated NAV due to the high interest rate holdings, and as rates go up and these same offerings become available on the primary market, the nav must fall. The premium on the vanguard bond desk for these offerings is 25% and better. Theres that 25% again.

Hence when one can buy tips from treasurydirect in the 3.xx% range (presumably when rates go up another .75% or better), the value of these bonds will lower by 25% or more.

Of course, buying tips on the secondary market with interest rates in the 3.xx% range also would suffer a loss of 25% or more (back to "100" from the 125+ they're at now par value) once those higher rate offerings reappear. So unless you're planning on holding the tips you buy to maturity, its a bad time to buy either the fund or the real bonds.

Yes? I'm still figuring this bond stuff out.

Wheres Alec when you need him?

 

[wabmester]

The coupon rates in a bond portfolio are almost completely irrelevant. (However, they do affect duration. In this case, they will *lower* the impact of rising interest rates on the NAV a bit, which is a good thing.)

TH, you're basically saying that you don't want to buy TIPS because you're sure the real coupon rate will increase. This is much less clear to me. You have to ask yourself why the real rate was ever as high as 4%. IMHO, it's because TIPS were novel in 1998 and they required a "novelty premium" to convince buyers to pick them up.

I don't think we'll ever see coupons like that again, but it's something to wish for

 

[charlie]

Wab mentioned that the only good reason for holding
a TIPS fund is for liquidity. Otherwise, holding individual TIPS to maturity is better. My question is this:

What if you are in the withdrawal stage and need
4% withdrawal rate for living expenses? At current
real rates, it looks like you can't get there from
here, with 100% allocated to TIPS, unless you buy a ladder of TIPS and cash them as they mature. That
seems awkward at best to me, but doable.

Bob_Smith, you recently bought long term TIPS at 2.5%
and I believe you plan to hold them to maturity. Would
you share your withdrawal strategy with us?

Thanks and Cheers,

Charlie

 

[wabmester]

Charlie, I've got a 10-year ladder that's a combination of CDs, TIPS, and other bonds. That takes care of about half of my income requirements for the next decade.

I also have longer term bonds, and like Bob_Smith I picked up a big chunk of 2.5% TIPS with maturities of 25+ years. The long-term bonds on the secondary market have high coupons (close to 4%), so you could directly live off of the coupon even though the effective yield is 2.5% (based on the price you'd pay for the bonds).

 

[bobbee25]

Where is a good place to park money that you probably won't need for 1 to 3 years, but ya may ?

 

[Cut-Throat]

Charlie, I've got a 10-year ladder that's a combination of CDs, TIPS, and other bonds. That takes care of about half of my income requirements for the next decade.

Wab,

What would you guess your ladder is besting a Short term bond index fund? In terms of a percent over the 10 years?

 

[wabmester]

What would you guess your ladder is besting a Short term bond index fund? In terms of  a percent over the 10 years?

Excluding TIPS, my weighted average coupon is just over 7%. Vanguard's short-term bond index fund yields just over 3%.

I only exclude TIPS because I don't know their total yield until I know what inflation will do, but if you assume inflation will be in the 2-5% range, 10-year TIPS will yield between 4-7%, which doesn't look too bad compared to other bonds.

I also own a chunk of short-term corporate, which I use like a money market. While the quoted yield is over 3%, there have been capital losses this year due to rising interest rates, so the return has been about zero YTD, which is very close to money market rates.

 

[Bob_Smith]

What if you are in the withdrawal stage and need 4% withdrawal rate for living expenses?  At current real rates, it looks like you can't get there from here, with 100% allocated to TIPS,  unless you buy a ladder of TIPS and cash them as they mature.  That seems awkward at best to me, but doable.  

Bob_Smith, you  recently bought long term TIPS at 2.5% and I believe you plan to hold them to maturity. Would you share your withdrawal strategy with us?

Charlie, since LT TIPS on the secondary market have coupons close to 4% real, you could conceivably spend down your assets without liquidating as you go and without laddering. That's one of the advantages I see in the older LT TIPS. I do plan to hold until maturity and will spend the coupon. But I'm not 100% in TIPS and I don't plan to be.

 

[Trace]

Dante,

Have you looked at what it is going to take to double your $1.0M? You can model your future contributions and use the "rule of 72" to get a rough idea of when your $1.0M turns into $2.0M. It may be easier to keep your existing house (and purchase health benefits) with $2.0M.

I have a goal to have $1.0M in investments and $500K in home equity by age 47. My plan is to turn the $1.0M into $2.0M/$2.5M by age 55 and retire. I will also have a pension at age 55 with Health Benefits.

You are an inspiration to us young dreamers.

 

[wabmester]

Where is a good place to park money that you probably won't need for 1 to 3 years, but ya may ?

Assuming you want to preserve capital, your choices are basically:

1) money market, and you can get up to 2.5% by using a corportate money market (Ford, GM, credit card companies, etc).

2) CDs, and you should be able to get something like 3% and an option to cash out early if you need to (hint: buy multiple CDs instead of one big one so you can cash out part of your funds if you need to).

3) i-bonds, currently paying over 3%, but limited to $60K a year per SSN

 

[Dante60093]

Dante,  

Have you looked at what it is going to take to double your $1.0M?  You can model your future contributions and use the "rule of 72" to get a rough idea of when your $1.0M turns into $2.0M.  It may be easier to keep your existing house (and purchase health benefits) with $2.0M.  

I have a goal to have $1.0M in investments and $500K in home equity by age 47.  My plan is to turn the $1.0M into $2.0M/$2.5M by age 55 and retire.  I will also have a pension at age 55 with Health Benefits.  

You are an inspiration to us young dreamers.  

Trace,

I have not actually thought about doubling the $1.0M in the next 8 years - I am assuming you mean through investment gains and savings - but now that you have mentioned it, I will.

If I continue to be employed the way I have been in the past, its probably possible to get to the $2.0M, but work-life balance would continue to suffer and I would not be able to free myself of this corporate bondage ever.

The other way to do it is to get a 9% annual return on my investments, and then in 8 years, I would be at $2M. To do this, I would have to get very aggressive with my asset allocation and I am not sure how to do that yet.

I never thought I would be an inspiration to the young dreamers but thanks.

What kind of steps are you considering to take to go from $1M to $2-2.5M?

Its terrific that you can get a pension and health benefits at 55. Is it a Fortune 500 company or a private firm that is still offering those kinds of benefits?

Dante

 

[Trace]

Dante,

I have worked for the same Fortune 500 company since graduating from College. I feel very fortunate to have a pension plan in addition to an employer match on the 401K.

My plan at age 47 is to have a 53% / 47% asset allocation and adjust this once a year (using the 100 - age rule). 53% would be the Vanguard Total Stock Market Index Fund. 47% Total Bond Market Index Fund (I would probably use the Short Term index fund instead at this point in time to lower the interest rate risk). I will probably make some minor tweaks to the asset allocation to gain some exposure to International and REIT.

I certainly understand that it may be more difficult to make this decision once you already have $1.0M in the bank