auction of 10-year TIPS next week

[JohnEyles]

Since no one has stripped TIPS yet, this instrument doesn't exist.

Actually, todays's announcement PDF says: "The securities being offered
today are eligible for the STRIPS program". I have no idea how one
can actually purchase these.

So, in theory, I suppose the lower coupon TIPS with the same YTM will leave you with less coupon reinvestment risk.

My point. The problem I see with reinvesting the coupon payments
is that they'll be perhaps $300-500 every 6 months (for the amount
I'm thinking to invest) so it's dubious I'd invest each one in something
good right away, and if I did the $10 or so commission would be an
issue.

Furthermore, the 2.375% coupon TIPS doesn't have a full 10 years left until maturity, so you still face that re-investment risk.

Ok, it's 9.5 years instead of 10 years.

 

[FIRE'd@51]

Actually, todays's announcement PDF says: "The securities being offered today are eligible for the STRIPS program". I have no idea how one can actually purchase these.

Yes, they are eligible for the STRIPS program, but to the best of my knowledge, no dealer has stripped them yet. We have talked about stripping TIPS on this forum before. I have been an advocate of this, mainly for the interest-only piece. You have just made a good argument for the principal-only piece.

My point. The problem I see with reinvesting the coupon payments is that they'll be perhaps $300-500 every 6 months (for the amountI'm thinking to invest) so it's dubious I'd invest each one in somethinggood right away, and if I did the $10 or so commission would be an issue.

If you really want to go this route, you might consider purchasing some of the much lower-coupon TIPS issued back when real interest rates were lower - e.g. the 1.625% TIPS due in 2015. This would minimize your re-investment risk over the next 7.5 years.

 

[JohnEyles]

Yes, they are eligible for the STRIPS program, We have talked about stripping TIPS on this forum before. I have been an advocate of this, mainly for the interest-only piece. You have just made a good argument for the principal-only piece.

I guess one buys a secondary with the lowest coupon you can find if
you really want a principal-only (same as a "zero" ?) and the highest
you can find if you really want a STRIP.

If you really want to go this route, you might consider purchasing some of the much lower-coupon TIPS issued back when real interest rates were lower - e.g. the 1.625% TIPS due in 2015. This would minimize your re-investment risk over the next 7.5 years.

Yeah, but really, even for that one the majority of the return is from
interest, so maybe this is all really a red-herring.

On another note, I believe the issue of markups on secondary offerings
is a red-herring too, at least if one is a Schwab client and given their
new policy (however, they did mention, when I pressed on the phone,
that although THEY have no markup on secondary treasuries, the
dealer they buy them from DOES). Nonetheless, the 10-yr TIPS due
1/17 is 96-31/32 on Bloomberg, and 97-1/32 at Schwab on a $30K
purchase; a difference of maybe 1 basis-point in YTM. Fluctuations
between now and Thursday's auction will probably swamp that.

Oh well, guess we've pretty much talked this one into the ground ...

 

[FIRE'd@51]

Agreed. In the absence of stripped TIPS, we are talking about nuance here (although it is an interesting theoretical discussion).

My comments above have assumed that the TIPS are held in a tax-deferred account, since the issue of taxes can alter the results, especially with the tax on the phantom interest (that would make a zero-coupon TIPS effectively useless for the purpose of preserving purchasing power if held in a taxable account).

The way I think about utilizing a 2.75% coupon TIPS is to hold it in a tax-deferred account and withdraw (to spend) the coupon payment. This would go toward meeting my total SWR goal (assuming one is willing to settle for the CPI-U as inflation). Every subsequent coupon would then increase by the CPI-U and the "real" value of the principal would be preserved in the tax-deferred account. Since I would be spending the coupons, I would have no re-investment risk.

 

[JohnEyles]

The way I think about utilizing a 2.75% coupon TIPS is to hold it in a tax-deferred account and withdraw (to spend) the coupon payment. This would go toward meeting my total SWR goal (assuming one is willing to settle for the CPI-U as inflation). Every subsequent coupon would then increase by the CPI-U and the "real" value of the principal would be preserved in the tax-deferred account. Since I would be spending the coupons, I would have no re-investment risk.

Great point.

Of course, I am not old enough to spend the coupon payments
(from TIPS held in my TIRA), but I suppose I can use them for
my no-brainer $2K/year Roth rollover ("no-brainer", 'cause my
state has hefty income-tax rate and does not tax first $2K of
IRA dist).

 

[FIRE'd@51]

Of course, someone under 59.5 who is using a T72 withdrawal plan would avoid the 10% early-withdrawal penalty.

 

[haha]

I would buy at auction for a real simple reason: its about the only time that you as a retail investor can get a bond with no markup/bid-ask spread/commission/pixel storage fees/wear & tear on beavers fee/etc. If you buy on the secondary market, bend over.

I think this problem is much less with treasuries bought through Fidelity or Schwab. The bid/ask yields are clearly displayed, and the commissions are transparent and low.

Ha

 

[joesxm3]

TIPS vs, I-Bond ??

Would someone please explain how to compare the TIPS expected 2.75% YTM with the I-Bond 1.3% fixed + 1.21% semi-annual inflation part (3.74% composite rate)?

Is it 2.75% vs 1.3% or is there more to the comparison?

Thanks.

 

[haha]

Would someone please explain how to compare the TIPS expected 2.75% YTM with the I-Bond 1.3% fixed + 1.21% semi-annual inflation part (3.74% composite rate)?

Is it 2.75% vs 1.3% or is there more to the comparison?

Thanks.

Details differ, but this is all you really need to know.
Ha

 

[cute fuzzy bunny]

There is also a big difference in how taxes are handled.
http://www.early-retirement.org/forums/f28/tips-vs-ibonds-14948.html

 

[JohnEyles]

Nonetheless, the 10-yr TIPS due
1/17 is 96-31/32 on Bloomberg, and 97-1/32 at Schwab on a $30K
purchase; a difference of maybe 1 basis-point in YTM. Fluctuations
between now and Thursday's auction will probably swamp that.

Speak of the devil, Bloomberg quote has increased enough to
drop yield by 0.1% today. Of course, it could have easily gone
the other way ...

 

[joesxm3]

There is also a big difference in how taxes are handled.
http://www.early-retirement.org/forums/f28/tips-vs-ibonds-14948.html

Thanks for the link bunny

 

[JohnEyles]

Looks like results of today's auction of 10-year TIPS just
announced: 2.625% coupon, 98.942199 price, 2.749% YTM.

Not too bad. A 2.75% "real" return supports a 4% SWR for
40 years. (Notwithstanding concerns about CPI under-estimating
real folks' inflation ...)

 

[cute fuzzy bunny]

Hey, it might over estimate your real inflation.

Theres also that matter about dying on schedule 40 years from now, or what your plan "B" is when the money runs out. Or further changes to the way the CPI is calculated that reduce the return, like the Boskin commission did for us a decade ago.

 

[JohnEyles]

Theres also that matter about dying on schedule 40 years from now, or what your plan "B" is when the money runs out. Or further changes to the way the CPI is calculated that reduce the return, like the Boskin commission did for us a decade ago.

It starts again ...

Yes, valid concerns. But conventional wisdom seems to be that
having 10% (at least) of portfolio in inflation-linked bonds is a
good idea. Which is about where I'm at now, about 2/3 TIPS and
1/3 ISM/OSM.

 

[cute fuzzy bunny]

Sorry for throwing some reasoned discussion on the pile. I'll try to avoid it as much as possible in the future.

Its a slightly red rubbed area. We had a pair of trolls running around a few years ago telling everyone to run like hell from anything except TIPS and to take the "real" rate and eat the portfolio, then be sure to die on schedule.

That didnt seem to be very prudent advice for the long haul ER. I believe both of those guys are experiencing some significant financial trouble after ten years of the tips-only diet.

In the meanwhile, as I mentioned in the other thread, the conventional wisdom seems...conventional. I'm not sure why inflation protecting a small slice of portfolio creates that much benefit, but then again, I guess as much diversification as possible is a good thing.

To a point.

Just "prairie dogging" the idea makes me wonder how an investor looks at a product like this, and says "Gee, some government agency crafts a formula...which is occasionally changed, which measures a working urban renter who pays no health care...which is nothing like me...and somehow that'll be close enough over 3-4+ decades to give me a reasonably linear and predictable return".

Dont get me wrong...offer me some TIPS with a 4% coopun and I'd buy some. At sub-3%...eh...

 

[FIRE'd@51]

We had a pair of trolls running around a few years ago telling everyone to run like hell from anything except TIPS and to take the "real" rate and eat the portfolio, then be sure to die on schedule.

I wasn't a member of this forum when this happened but, as I'm sure you remember, there were some TIPS issued around the turn of the century with coupons in the 4% range (I think the highest was actually 4.25%). If these were the ones to which the "trolls" were referring, it may have been pretty good advice. There would be no need to "die on schedule" with a 4% coupon and 4% SWR since the principal at maturity would have been CPI-adjusted (again I'm making the "heroic" assumption that CPI-U is somewhat representative of actual inflation). IIRC, your INTC colleague and buddy, clifp, said he owned a batch of these 4.25% TIPS.

 

[FIRE'd@51]

Looks like results of today's auction of 10-year TIPS just announced: 2.625% coupon, 98.942199 price, 2.749% YTM.

I'm surprised these weren't issued with a coupon of 2.75% since it would yield a price closer to par, i.e. 100.009. It seems that they don't want to issue these above par. The only thing I can think of is that the amount above par is subject to deflation risk, although I thought (perhaps incorrectly) only the inflation adjustment was subject to deflation risk. Can someone clarify this?

 

[cute fuzzy bunny]

At the time of the 'advice', the high yield tips were available on the secondary market only, at a price that made the yield pretty much the same as "new" tips with the lower, roughly ~2% coupons.

Since the 'trolls' were banned...by every early retirement forum i'm aware of, I think its safe to remove the "''" marks...

I'd feel worse about regularly bringing up these points if the folks who actually sell TIPS didnt point out the exact same potential drawbacks.

A quarter to half percentage point variance in CPI vs your spending inflation would sort of suck over a decade or two, or three or four.

 

[JohnEyles]

... then be sure to die on schedule.

Hopefully any prudent investor (who is not in a position to be able
to not deplete their portfolio under pessimistic scenarios) schedules
their death at least 5-10 years beyond their actuarial life expectancy.

I believe both of those guys are experiencing some significant financial trouble after ten years of the tips-only diet.

Yeah, same as any other XX-only diet, I reckon. I don't think anyone
here is recommending a TIPS-only portfolio. I plead guilty to having
posted a spreadsheet, months ago, showing how a TIPS-only portfolio
might be managed to provide a given SWR, but it was only as a
thought experiment, not a serious proposal.

I'm not sure why inflation protecting a small slice of portfolio creates that much benefit, but then again, I guess as much diversification as possible is a good thing.

Yes indeed, I think you could make the same argument for any
diversification move, e.g. "I don't see why protecting a small slice
of a portfolio against poor domestic-equitiies performance creates
that much benefit" ...

I'd feel worse about regularly bringing up these points if the folks who actually sell TIPS didnt point out the exact same potential drawbacks.

I'm glad you brought up these points - the first time - but I wonder how
often it's necessary to bring them up, in the same thread no less

 

[cute fuzzy bunny]

I guess I brought them up more than once because I thought we were having a discussion about it.

It doesnt seem that anyone was 'glad' that I brought them up because the facts I expressed were met with eye rolling and name calling.

I'm well aware that there is a type of investor that wants a measure of 'realness' or certainty or safety that they perceive this type of investment provides, and that pointing out the holes in that line of thinking is discomforting to them.

I'm also aware that a whole range of less experienced investors may be sucked into buying a low yielding adjusted product for which the adjustment may not even remotely apply...and screw themselves.

You know, the sort of folks who see glowing recommendations and buy clumps of Blockbuster, Movie Gallery and ISM/OSM only to watch the price drop like a rock? Then they find out later that the guy who was pushing them got out a week before at a favorable price.