Jonathan Clements and John Lim on bonds

[daylatedollarshort]

If you want to choose to ignore changes in fair value because you intend to hold to maturity then fine... I think that many here who invest for income have that mindset. But don't expect the rest of the world to look at it that way because it is unlikely to happen.

I assume most people who buy TIPS buy them for the yield and the inflation protection, similar to I bonds. The TIPS coupon is on the bond and the inflation factor is based on CPI, and the formula for calculating the current value and payments are found on the TD site - TIPS/CPI Data — TreasuryDirect. If you don't hold to maturity, you may not get the full benefits of the yield and the inflation protection, which is kind of the whole point, so that is not usually a recommended strategy, especially in a rising rate environment. A ladder strategy assumes holding each rung to maturity. But you do you.

Most posters here who invest for fixed income are buying individual bonds with the intent of holding to maturity, like in the Golden Period for bonds thread - https://www.early-retirement.org/fo...period-for-fixed-income-investing-114400.html.

ETA - If you hold your TIPS at TD, I assume they would just show their current TD value, and you would have to look up the price on the secondary market if you wanted to know that.

 

[pb4uski]

I assume...

Ergo, the problem. [emoji16]

 

[daylatedollarshort]

Ergo, the problem. [emoji16]

Another way to look at it is that I bonds currently have 0% real yield and a CPI inflation factor. Older TIPS can have a 2% real yield and a CPI inflation factor. TIPS return the par or par plus the inflation factor as long as they are held to maturity.

Yet you think I bonds are a great deal at 0% real yield, but 2% real yield TIPS, being held to maturity, have lost money this past year?

From the Fidelity web site - "TIPS are also subject to interest rate risk, just like other bonds. That means when interest rates rise, the market value of bonds is likely to fall. Rate risk may be managed by holding individual TIPS bonds to maturity, as in a bond ladder. If you hold TIPS until they mature, you will receive either the adjusted principal or the original principal, whichever amount is greater." - https://www.fidelity.com/learning-center/trading-investing/tips-and-inflation

 

[Montecfo]

Folks are free to view things in any way they want. But of course the reality is that all market traded bonds are subject to market risk.

And in this market, TIPS have produced negative returns this year. That does not mean they are a bad investment for the longterm, it is just reality. And anyone purchasing the individual bonds or a fund needs to understand that, as they will show interim gains or losses on the brokerage statements.

TIP (the longterm TIPS ETF) has a total return of -13% YTD.
https://ycharts.com/companies/TIP

STIP (the 0-5 yr TIPS ETF) has a total return of -3.5% YTD. You can find that figure also at the link above using the symbol STIP.

Some very short term TIPS would likely have done better.

For those interested, attached is a good summary of how TIPS work. It includes a sample table showing how the coupon rises with inflation since it is computed as a percentage of the principal, which rises with inflation.

"TIPS can be a buffer against long-term inflation, but TIPS investing isn't always straightforward."

https://www.schwab.com/learn/story/... fixed coupon rates,so do the coupon payments.

 

[daylatedollarshort]

Folks are free to view things in any way they want. But of course the reality is that all market traded bonds are subject to market risk.

And in this market, TIPS have produced negative returns this year. That does not mean they are a bad investment for the longterm, it is just reality. And anyone purchasing the individual bonds or a fund needs to understand that, as they will show interim gains or losses on the brokerage statements.

TIP (the longterm TIPS ETF) has a total return of -13% YTD.
https://ycharts.com/companies/TIP

STIP (the 0-5 yr TIPS ETF) has a total return of -3.5% YTD. You can find that figure also at the link above using the symbol STIP.

Some very short term TIPS would likely have done better.

For those interested, attached is a good summary of how TIPS work. It includes a sample table showing how the coupon rises with inflation since it is computed as a percentage of the principal, which rises with inflation.

"TIPS can be a buffer against long-term inflation, but TIPS investing isn't always straightforward."

https://www.schwab.com/learn/story/... fixed coupon rates,so do the coupon payments.

TIPS ETFs are not TIPS. ETFs do not have maturity dates. TIPS, as long as you hold to maturity, can make money when TIPS funds are losing money. This is the same issue with all bonds vs. bond funds we have been discussing all year here and is not unique to TIPS. Freedom56 points out these issues in the Golden Period for bonds thread and how to make money from bond funds being forced to sell at losses right now. It is only a golden period currently if you buy individual bonds with maturity dates.

This is also explained in the Schwab article you linked to and supports exactly what I have been saying:

"You can invest in TIPS either by holding individual bonds, or through a mutual fund or ETF. There are pros and cons to each approach. By holding individual bonds, you can plan to hold to maturity, meaning any short-term price fluctuations might not matter. Individual TIPS also can be good planning tools. While the amount at maturity isn't totally known in advance, given the principal adjustments, investors can expect a return of at least the original $1,000 principal plus or minus the principal adjustment.

With a mutual fund or ETF you can get more diversification than might be achieved by buying individual TIPS yourself, and usually at a low cost depending on the fund. You also get the benefit of professional management, and potentially better pricing on the bonds than you might get by investing in individual bonds yourself.Mutual funds and ETFs don't usually have a maturity date, so their prices or net asset values (NAV) will fluctuate, and there's no certainty about what that price or NAV will be at a point in the future."

Also explained here - "Buying a TIPS mutual fund will not protect your money in the way a TIPS does. In the short term, TIPS funds may be more risky than TIPS. TIPS are priced daily, based on a view of future inflation rates. Changes in interest rates affect their value.If you own the TIPS outright, you will receive your adjusted principal upon maturity.However, unlike a TIPS, a TIPS mutual fund does not mature. There is no guarantee that you will receive all of your money back when you withdraw it. - https://www.thebalancemoney.com/pros-and-cons-of-tips-mutual-funds-2466782#:

ETA - Also the Schwab article is out of date. Real yields on TIPS are no longer negative and are bumping up to 2% real yields again. That is over a 4% safe withdrawal rate for 30 years, before taxes. Current I bonds are still at 0% real yields, for comparison, and both TIPS and I bonds are CPI inflation adjusted.

 

[MichaelB]

Not true. Bonds do not trade every day. Some bonds only trade a few times per year. Brokerage firms use a "third party price" to estimate the value of individual bonds, GSEs, treasuries, or CDs after the market closes every day in your account. The prices are extremely conservative. For example I have a 6.75% 2023 note that has been called for 10/26/22 and the make whole call price is estimated to be about $102.75 plus accrued interest. The last trade price was $101.50. The third party prices has been fluctuating since the full call from $99 to 101.4. If anything it biases to the downside to the point where Fidelity recently issues a message to clients who have been buying CDs and corporate notes regarding the use of third part prices to estimate the value of the security and that the securities mature at par.

This is the definition from Fidelity:

"Third party pricing depicts a security's price formulated from a third-party vendor's proprietary pricing methodology; to establish this modeled price, a host of factors such as recent trade activity, size, timing, and yields of comparable bonds are used; in the case of a comparable bond, the vendor assigns a "fair market" yield to the security, then extrapolates a representative price based on the fair market yield assigned; in many cases, this modeled price provides price discovery and transparency for bonds that may not have traded for days, months, or even years; understandably, in scenarios where a security hasn't traded recently, attempting to accurately predict the "market price" can be a challenging endeavor; nevertheless, the vendor prices bonds on a daily basis

Note: Given the nature of the modeled pricing provided, it is not accurate to characterize such pricing as a "closing price" or to suggest that the price was based on specific recent (prior day's end of day) trading activity"

ETFs do not update every day all securities in their portolio and complaints have recently been made to the SEC as investors have no idea what the the real asset values are. Many don't use third part pricing for their portfolio and us a last traded price that may be from months ago. ETFs are now scrambling to update their NAV like the one below:


https://www.bakersfield.com/ap/news...cle_28101072-3375-5a35-891e-d3175dc00353.html

It should be noted that actively managed CEFs have started to mark down the value of their assets and have gone from trading at a discount to asset value to trading at a premium to asset value.

If what you mean is “a caveat”, then I agree. Some funds have thinly traded assets and use fair market price estimations.

That does not change the substance of my point. Comparing TIPs ETFs or mutual funds with individual TIPs is misleading unless both reflect the same market factors. If not, the same TIP can be in both portfolios and have different values.

It doesn’t matter why you hold one or the other.

To everyone participating in this discussion, a reminder that capitalizing and bolding is the equivalent of yelling IRL. Let’s all assume everyone here can read and we’re all friends, so let’s keep the tone down.

 

[daylatedollarshort]

To everyone participating in this discussion, a reminder that capitalizing and bolding is the equivalent of yelling IRL. Let’s all assume everyone here can read and we’re all friends, so let’s keep the tone down.

Sorry, will change to italics. Didn't realize that. My bad.

 

[Freedom56]

If what you mean is “a caveat”, then I agree. Some funds have thinly traded assets and use fair market price estimations.

That does not change the substance of my point. Comparing TIPs ETFs or mutual funds with individual TIPs is misleading unless both reflect the same market factors. If not, the same TIP can be in both portfolios and have different values.

It doesn’t matter why you hold one or the other.

To everyone participating in this discussion, a reminder that capitalizing and bolding is the equivalent of yelling IRL. Let’s all assume everyone here can read and we’re all friends, so let’s keep the tone down.

Sorry I was trying to differentiate my text from a cut and paste from Fidelity.

 

[Montecfo]

TIPS ETFs are not TIPS. ETFs do not have maturity dates. TIPS, as long as you hold to maturity, can make money when TIPS funds are losing money. This is the same issue with all bonds vs. bond funds we have been discussing all year here and is not unique to TIPS.

No one has debated this at any time in this thread. I think we all agree.

This is also explained in the Schwab article you linked to and supports exactly what I have been saying:

As stated, this is not in question.

What IS in question is your statement that TIPS are not subject to market risk. They are.

The other issue you seemed to react to is the idea that most TIPS have lost quite a bit of value this year, as have most bonds. I linked some of the returns. This is due to market risk.

I think if you agree with these points we are on the same page.

 

[daylatedollarshort]

What IS in question is your statement that TIPS are not subject to market risk. They are.

There is no market risk if you hold to maturity and don't buy funds without maturity dates. Problem solved. So simply don't buy them if you don't plan to hold to maturity. If you hold to maturity, the CPI inflation adjustments are similar to I bonds, which most posters here think are the greatest thing since sliced bread. Only current TIPS yields have 1.59 - 1.91% real yields, while I bonds are 0% real.

Yet 0% I bonds are a good deal but 2% TIPS are losing money this year? You have recommended in this thread people buy I bonds but stay away from TIPS because they've lost money this year, and then posted the returns from TIPS ETFs as proof.

I suggest you check out the Golden Period thread about the advantages individual bonds with maturity dates vs. funds in a rising rate environment. The issues you bring up with TIPS are not really TIPS issues, they are any kind of bonds in a rising rate environment issue, which is easily solved with either short term purchases or ladders and holding to maturity, which is of course what we are all doing in the Golden Period thread.

ETA - TIPS yields were negative in recent years. Now those yields are positive again and pretty decent, so if anyone wants to buy TIPS, buying now and laddering or dollar cost averaging, of course with holding to maturity, is actually something to consider.

 

[kevink]

There's a very good thread about TIPS on Bogleheads that sheds additional light on these issues:

https://www.bogleheads.org/forum/viewtopic.php?t=386923

Here's a snippet of one pertinent exchange between Tyler (of Portfolio Charts) and bond expert vineviz:

"Tyler: However, as can be seen with the YTD return of a fund like TIP (currently -13% before inflation) "removing all risk" only applies to TIPS held individually all the way to maturity rather than through a liquid index fund that is subject to interest rate risk. One of my main goals with the article is to illustrate the difference.

Vineviz: We haven't touched on this, but this "difference" is also not actually a difference. A TIPS has the same amount of interest rate risk for an investor whether held directly or through a fund. It's not the method of holding that matters, but rather the degree of mismatch between the investor's investment horizon and the bond/fund's duration.

It's simply not true that a TIPS fund like has interest rate risk but an individual TIPS does not."

Holding individual TIPS allows you to exactly match a specific future liability with a specific amount real return amount known in advance. That's a wonderful thing, but everything else is as Montecfo said and it applies equally to individual bonds and bond funds. Owning individual bonds (TIPS or nominals) and never checking their market value may indeed be a great support for staying the course but it certainly doesn't insulate you from market risk/interest rate risk.

Many people have access only to bond funds and ETFs in their tax-advantaged accounts and there's nothing wrong with using things like SCHP or VTIP to invest in TIPS within them. As vineviz points out, what's important is not the vehicle but matching the bond or bond fund's duration to your time horizon.

 

[daylatedollarshort]

There's a very good thread about TIPS on Bogleheads that sheds additional light on these issues:

https://www.bogleheads.org/forum/viewtopic.php?t=386923

Here's a snippet of one pertinent exchange between Tyler (of Portfolio Charts) and bond expert vineviz:

"Tyler: However, as can be seen with the YTD return of a fund like TIP (currently -13% before inflation) "removing all risk" only applies to TIPS held individually all the way to maturity rather than through a liquid index fund that is subject to interest rate risk. One of my main goals with the article is to illustrate the difference.

Vineviz: We haven't touched on this, but this "difference" is also not actually a difference. A TIPS has the same amount of interest rate risk for an investor whether held directly or through a fund. It's not the method of holding that matters, but rather the degree of mismatch between the investor's investment horizon and the bond/fund's duration.

It's simply not true that a TIPS fund like has interest rate risk but an individual TIPS does not."

Holding individual TIPS allows you to exactly match a specific future liability with a specific amount real return amount known in advance. That's a wonderful thing, but everything else is as Montecfo said and it applies equally to individual bonds and bond funds. Owning individual bonds (TIPS or nominals) and never checking their market value may indeed be a great support for staying the course but it certainly doesn't insulate you from market risk/interest rate risk.

Many people have access only to bond funds and ETFs in their tax-advantaged accounts and there's nothing wrong with using things like SCHP or VTIP to invest in TIPS within them. As vineviz points out, what's important is not the vehicle but matching the bond or bond fund's duration to your time horizon.

I think the proof is kind of in the pudding on the bond funds performance stats these days, TIPS and nominal, but your portfolio so you do you. If you want to come over to the dark side of individual bond holders, you are always welcome in the Golden Period and other threads. We have many bond fund refugees there.

From Fidelity: "Rate risk may be managed by holding individual TIPS bonds to maturity, as in a bond ladder. If you hold TIPS until they mature, you will receive either the adjusted principal or the original principal, whichever amount is greater......Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss." - https://www.fidelity.com/learning-center/trading-investing/tips-and-inflation

 

[kevink]

I think the proof is kind of in the pudding on the bond funds performance stats these days, TIPS and nominal, but your portfolio so you do you. If you want to come over to the dark side of individual bond holders, you are always welcome in the Golden Period and other threads. We have many bond fund refugees there.

From Fidelity: "Rate risk may be managed by holding individual TIPS bonds to maturity, as in a bond ladder. If you hold TIPS until they mature, you will receive either the adjusted principal or the original principal, whichever amount is greater......Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss." - https://www.fidelity.com/learning-center/trading-investing/tips-and-inflation

It feels a bit like trying to describe the globe to a flat-earther daylatedollarshort but here's one last stab at divesting you from your misconceptions about individual bonds vs. bond funds:

https://www.pragcap.com/the-biggest-myths-in-investing-part-5-bonds-lose-value-if-rates-rise/

From the first footnote:

¹ – A lot of people argue that individual bonds are safer than bond funds, however, this isn’t exactly accurate. Individual bonds expose you to significantly more individual entity risk and as I’ve shown here, a constant maturity bond fund is just as safe as an individual bond when it’s held for the right holding period. Unfortunately, the liquidity of bond funds often lures the investor into treating this long-term instrument as a short-term instrument. In fact, I’d argue that the ability to see your daily price fluctuations in bond funds significantly increases the behaviorally induced risk of short-termism in bonds.

 

[daylatedollarshort]

It feels a bit like trying to describe the globe to a flat-earther daylatedollarshort but here's one last stab at divesting you from your misconceptions about individual bonds vs. bond funds:

https://www.pragcap.com/the-biggest-myths-in-investing-part-5-bonds-lose-value-if-rates-rise/

Sorry, don't really follow random Internet articles or Boglehead posters. The Bond Book by Annette Thau has pretty clear pros and cons of bonds versus funds and matches what Fidelity says on their site. We've already hashed out the bonds versus bond funds on many threads this year and the yields and NAV losses on the funds currently speak for themselves. This article from a past thread covers the issues well - https://www.early-retirement.org/forums/f28/bond-vs-bond-fund-114703-9.html#post2816309.

 

[Freedom56]

It feels a bit like trying to describe the globe to a flat-earther daylatedollarshort but here's one last stab at divesting you from your misconceptions about individual bonds vs. bond funds:

https://www.pragcap.com/the-biggest-myths-in-investing-part-5-bonds-lose-value-if-rates-rise/

From the first footnote:

¹ – A lot of people argue that individual bonds are safer than bond funds, however, this isn’t exactly accurate. Individual bonds expose you to significantly more individual entity risk and as I’ve shown here, a constant maturity bond fund is just as safe as an individual bond when it’s held for the right holding period. Unfortunately, the liquidity of bond funds often lures the investor into treating this long-term instrument as a short-term instrument. In fact, I’d argue that the ability to see your daily price fluctuations in bond funds significantly increases the behaviorally induced risk of short-termism in bonds.

The author obviously does not understand that bond funds realize capital losses in a rising rate environment whereas the individual bond holder is laddering and all issues mature at par. This is why a bond funds have performed so poorly over the past decade. Bond funds have market risk. When you buy individual bonds and hold them to maturity or call, you eliminate that risk.

 

[pb4uski]

Another way to look at it is that I bonds currently have 0% real yield and a CPI inflation factor. Older TIPS can have a 2% real yield and a CPI inflation factor. TIPS return the par or par plus the inflation factor as long as they are held to maturity.

Yet you think I bonds are a great deal at 0% real yield, but 2% real yield TIPS, being held to maturity, have lost money this past year?

From the Fidelity web site - "TIPS are also subject to interest rate risk, just like other bonds. That means when interest rates rise, the market value of bonds is likely to fall. Rate risk may be managed by holding individual TIPS bonds to maturity, as in a bond ladder. If you hold TIPS until they mature, you will receive either the adjusted principal or the original principal, whichever amount is greater." - https://www.fidelity.com/learning-center/trading-investing/tips-and-inflation

I'm ok with all of that and I do view I Bonds are a great deal even at 0% real yield.

Lets say that I bought I bonds with a 0% real yield and new issue 5-year TIPs with a 2% real yield on the same date and have held them a year and need cash for some reason. With I Bonds, I pay an early withdrawal penalty for 3 months of interest... a couple percent or so. With TIPS, I need to sell them prior to maturity and get hosed on the decline in value due to the increase in interest rates.

It is similar for bank CDs compared to brokered CDs... with bank CDs you pay an early withdrawal penalty and with brokered CDs you redeem at fair value which is lower if interest rates have risen since issuance.

Don't get me wrong, I like both TIPS and I Bonds. I own I Bonds and am considering buying TIPS, cognizant but not ignorant of the interest rate risk, but that isn't a concern because I would plan to hold TIPS until maturity. But at the same time I wouldn't deny the I interest rate risk.

 

[daylatedollarshort]

The author obviously does not understand that bond funds realize capital losses in a rising rate environment whereas the individual bond holder is laddering and all issues mature at par. This is why a bond funds have performed so poorly over the past decade. Bond funds have market risk. When you buy individual bonds and hold them to maturity or call, you eliminate that risk.

This is literally on the Fidelity site comparing the advantages and disadvantages of individual bonds vs. bond funds.

Bonds vs. Bond Funds

Market Risk

Individual Bonds - If sold prior to maturity, market price may be higher or lower than what you paid for the bond, leading to a capital gain or loss. If bought and held to maturity investor is not affected by market risk.

Bond Funds - Market conditions constantly affect the fund’s value, although the diversification inherent in a fund generally reduces the market risk of any one bond issuer. When you redeem shares of a fund, the sale may result in a capital gain or loss.

 

[daylatedollarshort]

I'm ok with all of that and I do view I Bonds are a great deal even at 0% real yield.

Lets say that I bought I bonds with a 0% real yield and new issue 5-year TIPs with a 2% real yield on the same date and have held them a year and need cash for some reason. With I Bonds, I pay an early withdrawal penalty for 3 months of interest... a couple percent or so. With TIPS, I need to sell them prior to maturity and get hosed on the decline in value due to the increase in interest rates.

It is similar for bank CDs compared to brokered CDs... with bank CDs you pay an early withdrawal penalty and with brokered CDs you redeem at fair value which is lower if interest rates have risen since issuance.

Don't get me wrong, I like both TIPS and I Bonds. I own I Bonds and am considering buying TIPS, cognizant but not ignorant of the interest rate risk, but that isn't a concern because I would plan to hold TIPS until maturity. But at the same time I wouldn't deny the I interest rate risk.

The Fidelity site clearly states, bonds held to maturity are not affected by market risk. If you had a TIPS in a taxable account, you would pay taxes based on the year over year reference CPI increase and interest payments, also calculated on the reference CPI, not the secondary market value, unless you sold the bond. The secondary market value is irrelevant for computing the inflation increase and interest payments. For the CUSIP 912810QP6 in the one year period I calculated, that comes out to an increase of 8.27% in the principal, plus the interest rate of 2.125%, more than 0% I bonds, not a loss, over a comparable period.

If you don't have enough cash in short term Treasuries, money markets, stable value, etc. where you might need to cash in your TIPS before maturity, then they may not be the best investment choice for your portfolio.

 

[jebmke]

This is literally on the Fidelity site comparing the advantages and disadvantages of individual bonds vs. bond funds.

Bonds vs. Bond Funds

Market Risk

Individual Bonds - If sold prior to maturity, market price may be higher or lower than what you paid for the bond, leading to a capital gain or loss. If bought and held to maturity investor is not affected by market risk.

Bond Funds - Market conditions constantly affect the fund’s value, although the diversification inherent in a fund generally reduces the market risk of any one bond issuer. When you redeem shares of a fund, the sale may result in a capital gain or loss.

I'm never selling equity so that risk doesn't affect me either.

 

[Montecfo]

I only buy stocks that go up, so not subject to market risk. Problem solved.

 

[jldavid47]

I only buy stocks that go up, so not subject to market risk. Problem solved.

Wow. Can I borrow your crystal ball?

 

[Chuckanut]

Don't get me wrong, I like both TIPS and I Bonds. I own I Bonds and am considering buying TIPS, cognizant but not ignorant of the interest rate risk, but that isn't a concern because I would plan to hold TIPS until maturity. But at the same time I wouldn't deny the I interest rate risk.

Well said.

 

[daylatedollarshort]

I only buy stocks that go up, so not subject to market risk. Problem solved.

Stocks don't have a maturity date with a guarantee by the government to buy them back for the par value, or value plus accumulated inflation for inflation protected bonds, like TIPS and Treasuries. That is the key difference. Stocks, stock funds and most bond funds don't have maturity dates. That is simply a fact, not a matter of opinion. Individual bonds have maturity dates. There is really no point in debating matters of fact like that. If you don't believe bond basics laid out in bond books and the Fidelity site, of course, your choice, but that is simply bond math. A $10K bond bought at par returns $10K at maturity.

This is also explained on the SEC site - Bonds, Selling Before Maturity | Investor.gov

 

[aja8888]

Wow. Can I borrow your crystal ball?

No problem, the stock market always goes up. If you don't believe me, have a look at Japan's market performance and maybe some others. Of course, in the U.S. we are "different"!

 

[Markola]

Investing styles come in and out of fashion. One is either a committed buy and hold index fund investor Boglehead or something else.