Quest for yield verus safety

[Bob_Smith]

Quote:

The "yield to maturity" on all bonds is calculated the same way, but it is easier to understand on conventional bonds that have a fixed par value of $1,000.

Thanks Ted. I think I have the whole picture now and your assistance is greatly appreciated. I wrote up a brief summary for my future reference so I could have it all in one brief summary. I thought I may as well include it here in case anyone else is following the minutiae of buying TIPS on the secondary market. I may be the only one who didn't already know all of this, but just in case, I'll post my notes, and I thank you for clarifying all of this.

---------------------

Understanding Prices & Yields of TIPS Sold on the Secondary Market

Sample Bond - This Was an Actual Bond Offering on 11/9/2003

A) Qty: 1001/1001
B) CUSIP: 912810FD5
C) Coupon: 3 5/8
D) Maturity: 04/15/2028
E) Bid Price: 119-22
F) Offer Price: 120-10
G) Bid Yield: 2.539
H) Offer Yield: 2.508

Understanding TIPS Prices:

1) The bond price is listed above as 120-10 which means 120 and 10/32% or 120.3125%.
2) Go to http://www.publicdebt.treas.gov/of/ofinflin.htm and select this specific bond. All TIPS are listed there.
3) Find the Index Ratio for this bond. The ratio changes each day, so use the index ratio for the day you plan to buy the bond. In this case I will use 11/9/2003. The index ratio as of that date is 1.14233. This tells me how much principal has accrued in the bond since it was originally issued at $1000. Unlike regular bonds, the principal of TIPS are adjusted per inflation. It would also be decreased if there was deflation, but the buyer is guaranteed to get the original $1,000 back in the end. In this case, the principal value of the bond on 11/9/2003 is 1.14233 x $1000 (the original/par value) = $1142.33. This is the bond's current par value.
4) Now go back to the offer price of 120.3125% and multiply that by the current par value of the bond ($1142.33). $1142.33 x 120.3125% = $1374.37. That is the offering price of this specific bond on 11/9/2003.

Understanding TIPS Yields:

1) In this case, the bond is yielding 3 5/8% (3.625%) per the initial auction. The bond itself never changes as it passes from one person to another. So if the interest payment were made on 11/9, it would look like this: (1/2 x .03625) x $1,142.33 = $20.70 (for 6 months) which is 3.625% of the current par value.
2) $20.70 (for 6 months) is also 3.01% of the $1374.37 offering price of the bond.
3) However, the TOTAL yield to maturity is actually only 2.508%. Why? Because the buyer will pay $1374.37 for a bond that has a principal value of only $1142.33. All subsequent inflation adjustments to the principal will be applied to the $1142.33, and NOT to the $1374.37 paid for the bond. When the bond matures, the buyer receives $1142.33 and all of the inflation/deflation adjustments applied to that principal throughout the life of the bond, or $1000, whichever is higher. This reduces the yield to maturity to 2.508%.

Thanks Ted!

I understand the appeal of TIPS (common stocks too).
I just don't want any. Plenty of other investments
out there. My broker recently tried (again) halfheartedly to
put me into a fund with stocks in the mix. I declined
(again) for all the same reasons. I want predictability
in my income stream and reasonable assurance that my base will still be there at maturity. My real estate
provides inflation protection. Perfectly content
to bump along cashing the same checks each month
even if the DJIA goes to 20000. It's the price I pay
for not having to worry about the market going in the
opposite direction.

John Galt

[unclemick]

Hey John Galt

Sounds to me you're accompishing with real estate what I'm trying to do with balanced index funds.

First nail down an income stream to cover my 'core budget' - (pension,REiTS,DRIP dividend stocks,conv bond fund, and someday SS).

The balanced index funds(IRA) are laniappe - fight inflation and provide the fun part of ER - with SWR of 4% as a guidepost.

I trust your real estate is structured so if one single investment goes south you have a backup plan.

[Ted]

Quote:

Ted, Do you know of any good books on strategies for investing in TIPS?

For my information on TIPs, I rely mainly on the Treasury Department's web site. For determining how they would affect the performance of a retirement portfolio, I "play around" with FIRECalc. (That is one of the features of FIRECalc that makes it better than various other "retirement" calculators.) I also have the practical experience of having very successfully owned some TIPs in a brokerage account for about 5 years (in spite of having had the broker try to sell me something that would have paid him a higher commission).

I obtained an MA in economics in 1988, took several courses in finance as part of that, and did most of my reading of books back then. Now I am more inclined to read articles in business periodicals and apply my theoretical knowledge to the specifics of current market conditions.

I wouldn't think that a book exclusively on TIPs would sell very well, but TIPs should certainly be included in new books on investing in general, because they are a truly unique and legitimate investment. Most people should combine TIPs with other assets, but it would be reasonable for someone who was interested strictly in capital preservation to put all of their long-term assets into TIPs.

Hi unclemick! Yes indeed, I do have a "back up" plan,
and you are correct in how I have structured my
meager ER stash. The real estate is well located,
and relatively affordable (larger pool of buyers that way). So, as I've said before, even if all my investments (except the real estate)
went to -0- I would not have to go back to work,
although my ER lifestyle would need to be revised.
BTW, I have been investing in real estate my entire adult life. I even considered going into it
full time when I was younger. I've owned houses,
apartments, raw land, commercial property, etc.
Real estate has been good to me.

John Galt

[dory36]

I, for one, would love to see John Galt start a thread on a "how to" for real estate investing.

I did this many years ago, and might want to get back into it. I've looked at a handful of books, but "real life" discussions would be nice.

So, what do you say, John Galt?

Dory36

[unclemick]

I second Dory 36's proposal.

Given my checkered past in real estate - spotted owls on land in Oregon, school taxes quadrupaled in Washington, gold mine(patented) in Colorado, timberland in Mississsippi - and others - I'm wonderering what rules I should have followed. The duplex in N.O. was okay but I hated being a landlord even with good tenants and making a modest amount of money.

AND we've known a few retiree's who actually do well - raw land, rentals, fixing houses, etc.

My skills(not!) sent me to Bogle(balanced index funds) and DRIP stocks- electric, gas. water, banks, oils - and other dividend players - 90% of the ER horse I rode in on.

?? Is there a personality type for real estate ??

[Ted]

Real estate investing certainly deserves discussion -- not just of the returns that some people have experienced, but also of the risks. *For most people, the most practical way to invest in real estate (other than their house) is through REITs, and funds like Vanguard's REIT Index or Fidelity's Real Estate fund are good ways to do it.

One thing to remember about the huge capital gains that some people have experienced in real estate transactions is that the "gains" that they brag about often don't consider the costs that they paid over the years, such as realty commissions, taxes, and insurance and maintenance on structures. *In line with the principle of "no free lunch," there aren't too many real estate investments out there that are going to provide an extraordinary return on invested equity.

One of the keys in real estate (as in many other
investments) is to buy cheap. Then, of course there
is the old "location, location, location". More by accident than design, most of what I have owned over the past
15 years was waterfront or near waterfront property.
Made a huge difference when I went to sell. I recall
that back in my active real estate dabbling days, I made
about 15 straight formal offers to purchase without getting a single taker. The reason? I lowballed
every one. If you do this long enough, someone will
bite. Then all you need is patience and maybe a little
creativity.

John Galt

From a mostly financial standpoint, I would prefer to rent our home and keep my real estate money
elsewhere. We would like to become snowbirds, but this
requires owning at one end only. So far, we have not
found suitable rental property at either end and so
the search continues. Maybe we are too fussy.
Owning 4 dogs doesn't help any either.

John Galt