Buying 5-year TIPS at Monday's auction

[astromeria]

If you care to, please share why/why not.

 

[Nords]

Don't need bonds, and especially don't like bonds carrying a phantom tax.

 

[Patrick]

Don't need bonds, and especially don't like bonds carrying a phantom tax.

What is the "phantom tax?"

 

[haha]

If you care to, please share why/why not.

I already have my order in. Soon almost all my tax-deferred money will be in fixed income, most of it inflation adjusted.

The why? I think this 2.6 or so above CPI is not bad, and I think inflation might turn out to be big deal after all. In fact, it is already.

Ha

 

[Nords]

What is the "phantom tax?"

You're taxed on TIPS returns that you actually don't receive until the bond matures.

When TIPS are adjusted for the CPI, the adjustment is made to the bond's principal instead of to its coupon. So the bond is worth more, although you don't receive that additional value until it matures (or you sell it). However the IRS taxes the additional value in the year it's applied to the principal, not in the year that you get your hands on it.

The phantom tax has led many to conclude that TIPS are more suitable for a tax-deferred account. However that means unless you're taking RMDs or a 72(t) distribution from the account you won't be able to spend the income stream. So unless held in a taxable account where phantom tax has to be paid, TIPS apparently provide inflation protection without an income stream.

You financial guys probably have a better description-- please leap in and correct or clarify.

 

[astromeria]

I'm with Ha--I put my order in this morning in my Fidelity rollover IRA.

-- No pension here, and fixed-income-wise, I am way heavy-weighted in corporate bonds, CDs, and MMAs. Other than gov't bonds within some of my hybrid funds, these are my only gov't bonds. I can't bear to buy pure bond funds...I just can't. TIPS are as close as I can get myself to a bond fund!

-- My TIPS are tax-deferred.

-- I don't need the income stream quite yet. I'm 57 and can grab the cash as soon as they mature in 5 years.

-- This is my only official inflation-protected investment, and it represents just 3% of my portfolio.

-- Would prefer I-Bonds (2/3 of our stash is taxable), but they appear to be a worse investment right now (fixed rate way too low...but I'm a buyer if it goes up).

I'm not the sharpest investor in this drawer (more of a mushroom brush....), so someone (Nords?!) will surely tell me the error in my ways!

EDIT I should add that although I'm retired, my husband still works--hence no need for an income stream yet, not until he retires, too (tiny pension for him at age 65...wouldn't even pay the grocery bill now).

 

[wabmester]

You're taxed on TIPS returns that you actually don't receive until the bond matures.

You have some CD's, right? Me too. And I ask the bank to reinvest the interest for me to maximize my compounding. Even though they don't cut me a check for the interest until the CD matures, I still have to pay tax each year on the interest. OMG! A phantom tax!

Also, if you pay state income tax, you're paying for that phantom CD interest at the state level as well as the federal level. At least with TIPS, there is no state tax.

 

[haha]

-- This is my only official inflation-protected investment, and it represents just 3% of my portfolio.

Roughly 1/4 of my invested assets are inflation protected bonds of maturities up to 20 years. (Including what I will buy on Monday.) I also bought in the last auction of 10 year notes. I know they are not perfect, and at too high a price they probably stink- but today I like them well enough.

I like to buy equal to or below the original issue price. I don't want to buy inflation adjustments already added to the bond price, because as I understand it at least, these can be lost if we should encounter deflation. (Fat chance, IMO, but why buy a quibble that you are not being compensated for?)

Ha

 

[Gone4Good]

You're taxed on TIPS returns that you actually don't receive until the bond matures.

Theoretically, if you pull your tax payments out of the CPI accretion, your after-tax returns should be the same as a normal bond. Practically, you may have some capital gains / losses that could lessen / improve your actual after-tax returns relative to a normal bond. On balance, I'm not sure the tax implications for TIPS matter that much.

 

[JohnEyles]

If you haven't seen it already, please check out my lengthy
posting on Page 5 of the thread "Bond Funds? Question about Rational Investing".
I present a spread-sheet showing laddered 5-year TIPS to produce a more or
less inflation-proof income stream of almost 4% of initial portfolio value.

I'd be curious of people's thoughts, because I too am trying to decide whether
to sink a significant percentage of my portfolio into the upcoming TIPS.

 

[wabmester]

I'd be curious of people's thoughts, because I too am trying to decide whether to sink a significant percentage of my portfolio into the upcoming TIPS.

John, you've gone from being a TIPS skeptic to a TIPS fan in just a couple of days. If I were you, I would slow down a bit. Do you have an immediate need to "sink a significant percentage" into TIPS?

TIPS aren't very popular around here. At least not during a 4-year bull market. So, you're not going to get a lot of TIPS love. (That may change during the next bear, though.)

HaHa likes TIPS. (Mikey likes it!) He's probably the most successful long-term investor on this board, and he has a pretty good gut feel as well as good depth of knowledge.

I like TIPS in moderation. Yes, they're a better deal than annuities. Yes, they'll give you the most predictable real return available, but that return is currently 4.5% below the historical average return of stocks. Stocks (and real estate) are probably still going to be better investments in the long term.

And, of course, there's always the issue that the CPI isn't the same as your personal rate of inflation, so take the whole idea of a 4% SWR with a large grain of salt.

With the 5-year TIPS at 2.6%, TIPS will do well as long as inflation stays above 2%. Inflation has only been below 2% about 4 years out of the last 40, so that looks like good odds for the current batch of TIPS.

 

[2B]

The last time 5 year TIPS were sold was in late April. It only carried a 2.375% interest or a "real return" of 2.375%. This is very low from a historical perspective for US Treasuries. To "break even" against regular 5 year treasuries, you need inflation to run at around 2.5%. Reasonable to assume but not very exciting when compared to the early TIPS that carried much higher "real returns."

This is not an exciting time in the fixed income world. I currently have very little and I'm not planning to add any at the present time.

 

[Gone4Good]

To "break even" against regular 5 year treasuries, you need inflation to run at around 2.5%.

I might rephrase this to read: "To break even against regular 5 year treasuries, you need inflation to run at only 2.5%."

At inflation rates higher than ~2.5% you're better off owning TIPS then treasuries.

 

[2B]

At inflation rates higher than ~2.5% you're better off owning TIPS then treasuries.

Be careful you don't fight the "last war." We now have a Fed Chairman that's an advocate of "inflation targeting." So far, the countries that have implemented this approach have kept inflation low but also had lagging economies. The inflation we have been seeing are primarily due to housing, raw material and commodity prices.

By any historical standard, a 2.375% real return is poor.

 

[wabmester]

By any historical standard, a 2.375% real return is poor.

Not sure what your definition of "poor" is, but the 50-year average real return on LT treasuries is 2.554%. The 50-year average real return on T-bills is 1.273%.

2.375% for a 5-year sounds OK to me. But wait, it gets better than that!

2.375% is the *coupon*, not the yield of the 5-year. The current yield of that issue is 2.65% real.

The current yield of the nominal 5-year is 4.76%.

The break-even inflation rate is 2.11%.

 

[JohnEyles]

Do you have an immediate need to "sink a significant percentage" into TIPS?

Just trying to get my portfolio into shape. (FYI, I am a newly retired 53yo,
trying to arrange income of $50K, including $15K of 20%-derated SS at 64yo,
from a portofolio of $1M). I was looking at the buckets approach, but kinda
backed away from that. At any rate, I figure I want about a 60/40 stock/bond
split and right now I have only 11% in bonds - not that I have too much in
stocks, but way too much in cash - and almost nothing in real estate so far
(planning to jump into VNQ big when the tea leaves look right).

My meager bond allocation is so far a hodge-podge from my previous disjointed
investment history plus some new acquistions after participtaing here (MMBFX,
AGG, PPT, LSGLX, SWBDX, TIPBX, IHYAX, and some in the CREF retirement acct).
But NO treasuries, other than some 6-month T'Bills, which I consider "cash".
So I was thinking about heading towards 20% TIPS (half my bond allocation)
starting with 4% this year and 4% in each of the next 4 years; kinda of a ladder
(without the short-maturing start-up bonds) and kinda a DCA into this investment
class (presuming the coupons will be better on the subsequent 4% moves).

Does this seem overboard-about-TIPS ?

 

[astromeria]

I'm in a very similar situation and mind-set, JohnEyles. Approx the same amount of portfolio, overweight cash and corporate bonds, plan = gradually increasing government bonds.

 

[2B]

I'm in a very similar situation and mind-set, JohnEyles. Approx the same amount of portfolio, overweight cash and corporate bonds, plan = gradually increasing government bonds.

You can almost always get better rates on FDIC insured CDs. If you spread it around you can easily cover a few hundred thousand with the insurance and still get a nominal 1/2% over 5 yr Treasuries.

I see TIPS and I Bonds with their low base yields as refuges for those wanting to relive the 1970's.

 

[wabmester]

Does this seem overboard-about-TIPS ?

No, that sounds about right to me: 50% TIPS and 50% nominal ensures that you're covered in both cases of inflation above and below current estimates.

2.65% real on the 5-year is the best we've seen in years, so it looks like a pretty good deal to me, but I would still keep some cash in reserve just in case we see even better deals in the months/years ahead.

The peak of the real yield on TIPS occurred during the top of the dot-com bubble, when nobody wanted to touch bonds. If the current bull continues its run, we might see those yields again.

Edit: Something else to consider from the bond gurus at Pimco. They think the fed has intentionally over-tightened to pop the housing bubble. They believe that a neutral funds rate is closer to 3% and than yields have peaked.

If the fed eventually lowers to around 3%, the real yield on the 5-year will drop to 1% or less. If that happens, that means the current offering of 2.65% is a stellar opportunity....

 

[astromeria]

You can almost always get better rates on FDIC insured CDs.

Yup. I have a lot in CDs already--and all of it is taxable, and none is inflation-protected. And I'm not living on this income stream yet, just paying taxes on the interest. But if 6% CDs come back (hello PenFed!), I may buy a few more. I can be seduced am opportunistic.

 

[Mr._johngalt]

for those wanting to relive the 1970's.

I'll tell you what folks.......at my age "reliving the 70s" sounds pretty
good.

JG

 

[2B]

I'll tell you what folks.......at my age "reliving the 70s" sounds pretty
good.

JG

I'd be glad to be 20 again (maybe) but I could do without the 20% inflation.

 

[astromeria]

I'd be glad to be 20 again (maybe) but I could do without the 20% inflation.

and the polyester leisure suits

 

[2B]

and the polyester leisure suits

Never owned one. My brother bought one and I thought he looked like an idiot. Actually, he did before but the leisure suit really nailed it. I did have one of those polyester/black light shirts.

 

[JohnEyles]

2.65% real on the 5-year is the best we've seen in years, so it looks like a pretty good deal to me, but I would still keep some cash in reserve just in case we see even better deals in the months/years ahead.

Well, I am keeping cash in reserve, only buying 4% of portfolio on Monday, investing
the other 16% into TIPS over the next 4 years.

Please help me to understand how it is that we refer to the return on this current
TIPS as 2.65% ?? I see it at Bloomberg the same as you do; but how is it calculated ?
I realize the price of the bond is $98.27 per $100 of par value, but I see that
2.375% * (100/98.27) is only about 2.417%. Maybe because the principal at
maturity is based on the par value and not the price, but I still cannot make the
number work out.