Tips for a TIPS ladder?

[Curmudgeon]

I use FutureAdvisor and SigFig to analyze my portfolio and summarize any shortcomings/issues. I don't necessarily accept everything they say, but it's an easy way to analyze a portfolio and get some quick feedback.
One of the things both of them have been telling me is that I should have ~20% of my portfolio in TIPS. So, I am considering establishing a 10-year ladder in my tax-deferred account, with one set maturing each year. YTM on the shortest-term TIPS runs a tenth or two of a percent, while the 10-year maturities run a bit above 0.4%. Breakeven yield seems to be running about 2% right now, meaning that if inflation over the next 1-10 years runs higher than 2%, I'd come out ahead on investing in TIPS vs nominal bonds. These all have pretty small coupons - generally 1/8% - so they wouldn't generate any meaningful income, but with 2% of my portfolio maturing every year at an inflation-adjusted payout, these should generate about half or more of my spending needs each year if I need to dip into them. By holding to maturity, I'm immune to interest rate risk.

Any thoughts or feedback? Is putting 20% into TIPS a reasonable move? Any reason to go with a shorter, or longer, set of maturities (i.e. a 5-year or 20-year ladder)?

 

[capjak]

I think boggle heads has a lot of debate on this one, maybe go there and present your question also

https://www.bogleheads.org/forum/index.php?sid=31668eff8395a7a574c0b54fef497adb

 

[ShokWaveRider]

Why do this if one can get 3% in CD's? (What I am getting now for the next 24 months).

 

[capjak]

Why do this if one can get 3% in CD's? (What I am getting now for the next 24 months).

Do you mind telling us where you can get 2 year CD for 3.00%

 

[ShokWaveRider]

Do you mind telling us where you can get 2 year CD for 3.00%

Last >2 years of a 5 year CD. While I will agree it is not quite available yet. 2.5% -2.74% is, or at least I have seen them in passing. By the time mine mature I am sure they will be back. PenFED has them for 2.27% today.

 

[Curmudgeon]

Why do this if one can get 3% in CD's?

Because if inflation goes to, say, 4%, your CD's will earn you 3%, and the TIPS will earn 4.5%.

(I have a 2-year CD ladder, the most recent additions are earning me 1.8. If inflation runs 2.5%, then a 2-year maturity TIPS would get me maybe 2.75%, better than my CDs.)

 

[ShokWaveRider]

Because if inflation goes to, say, 4%, your CD's will earn you 3%, and the TIPS will earn 4.5%.

(I have a 2-year CD ladder, the most recent additions are earning me 1.8. If inflation runs 2.5%, then a 2-year maturity TIPS would get me maybe 2.75%, better than my CDs.)

"IF" a big IF.

 

[daylatedollarshort]

I have bought most of ours at auction over the years, using a highly scientific method. I tell DH the upcoming term and expected yield and how much we have in cash at that time, ask how much he would buy at that price, add it to what I was thinking, divide by two and put in the bid.

We have both CDs and TIPs.

 

[Curmudgeon]

"IF" a big IF.

I'm not seeing your point. TIPS are protected against inflation; CDs are not. 2.5% inflation does not seem like a "big IF"; over the last 12 months it was 2.2%. Right now a TIPS maturing in 1/15/2023 yields 0.28%, if inflation is >2% it will beat your PenFed 2.27% rate.

Or, are you saying that you think inflation is headed downward from here on out? If so, then yes this is the one real risk: if inflation is lower than 2% over the next 10 years then I lose. But if it is higher, I win; and the higher it is the more I win.

 

[jazz4cash]

Wouldn't TIPS work better in a taxable account?

 

[Curmudgeon]

Wouldn't TIPS work better in a taxable account?

I think that's generally no - the gains are all treated as regular income (so no tax advantages), and you actually have to pay tax every year when they update the principal amount - so, you're paying tax on money you haven't even been paid yet. They are exempt from state/local taxes, though, so I guess there could be cases where it makes sense.

 

[OldShooter]

I view our TIPS as an insurance policy against high inflation, which is the only serious risk we face in retirement. Any trivial yield shortfall is simply the cost of that insurance.

 

[ShokWaveRider]

I'm not seeing your point. TIPS are protected against inflation; CDs are not. 2.5% inflation does not seem like a "big IF"; over the last 12 months it was 2.2%. Right now a TIPS maturing in 1/15/2023 yields 0.28%, if inflation is >2% it will beat your PenFed 2.27% rate.

Or, are you saying that you think inflation is headed downward from here on out? If so, then yes this is the one real risk: if inflation is lower than 2% over the next 10 years then I lose. But if it is higher, I win; and the higher it is the more I win.

I understand your point. Inflation is subjective though, in another post we talked about it. Over the past 10 years for DW & I inflation has been almost flat. Yes a couple of things have gone up. But property taxes have actually gone down. We calculated based on our own personal budget spreadsheets over the last 10 years of which we have been retired for 6, it has been all but flat. So FOR US our 3% CDs are doing just fine.

 

[Curmudgeon]

I understand your point. Inflation is subjective though, in another post we talked about it. Over the past 10 years for DW & I inflation has been almost flat.

One thing to note: The people who set inflation rates on TIPS don't care what your personal inflation rate is . It is set according to the national CPI. So if you had purchased TIPS a year ago you would have seen a 2.2%+ gain, despite the fact that your own 'subjective' inflation rate was low.

 

[big-papa]

there are of course other options
1. Some people use Ibonds for this. But there are restrictions $10K per SS per year + up to $5K from tax refunds per filing. Taxes on earnings are deferred until the bonds are cashed in. Also, treasury doesn't increase the dollar amount you can use to buy bonds each year based on inflation, so also consider that.
2. Bobcat2 over on bogleheads talks about how to use TIPs funds to approximate the same thing as a ladder. One would use one a shorter duration TIPs fund and a larger duration TIPs fund. Then with some algebra you can figure out the proportion of the shorter duration fund and longer duration fund to approximate the equivalent of a ladder. Almost surprised that no fund company has done this already. A little messier if you want to add new money along the way, but completely do-able.

 

[Lsbcal]

...

Any thoughts or feedback? Is putting 20% into TIPS a reasonable move? Any reason to go with a shorter, or longer, set of maturities (i.e. a 5-year or 20-year ladder)?

As you know real rates are well below historical. So for me this is a red flag to not establish a ladder all at once. The yield curve is just a current snapshot. Who knows how it will look a few years out.

I have not seen any dialog on bond ladder setup that addresses this issue of initial ladder creation. It seems to me that the way a ladder works after it is setup is to replace the currently maturing rung with a new rung at the farthest out point. But what about the initial state? Do you setup that ladder immediately accepting today's rates along the full spectrum of maturities? Seems inconsistent with the idea of having rungs setup at various time points to smooth things out.

Just my thoughts, I've never done a ladder of bonds. Just bond funds. But I have owned individual TIPS in the past. I would only consider TIPS if the real rates were nearer historical levels. So for instance, if 10 yr rates were 2% then I might buy some.

You might consider instead short term investment grade which will adjust to unexpected inflation more quickly (duration = about 2 years). See my thread on intermediate/short term IG with data on the inflationary 1960's through 1970's.

 

[Curmudgeon]

Thanks Lsbcal! Good points to consider.
I get your point about establishing a complete ladder with rates at historical lows. Although, I think this concern is mitigated a bit by the fact that although I may be setting up (say) a 10-year ladder, the average maturity would only be half of that, and some will actually mature in just one year, so I can still take advantage of rising rates when/if they start to do so.
I could stretch the startup out over a few years, hoping to benefit from rising rates, but then I'm also susceptible to a falling rate risk - if you believe that is possible.
I do have some short term corporates, like VFSTX, but the real yield on those is pretty low, too. I'll take a look at your other thread.

 

[PoorOldCountryBoy]

I use FutureAdvisor and SigFig to analyze my portfolio and summarize any shortcomings/issues. I don't necessarily accept everything they say, but it's an easy way to analyze a portfolio and get some quick feedback.
One of the things both of them have been telling me is that I should have ~20% of my portfolio in TIPS. So, I am considering establishing a 10-year ladder in my tax-deferred account, with one set maturing each year. YTM on the shortest-term TIPS runs a tenth or two of a percent, while the 10-year maturities run a bit above 0.4%. Breakeven yield seems to be running about 2% right now, meaning that if inflation over the next 1-10 years runs higher than 2%, I'd come out ahead on investing in TIPS vs nominal bonds. These all have pretty small coupons - generally 1/8% - so they wouldn't generate any meaningful income, but with 2% of my portfolio maturing every year at an inflation-adjusted payout, these should generate about half or more of my spending needs each year if I need to dip into them. By holding to maturity, I'm immune to interest rate risk.

Any thoughts or feedback? Is putting 20% into TIPS a reasonable move? Any reason to go with a shorter, or longer, set of maturities (i.e. a 5-year or 20-year ladder)?

20% sounds like a lot, to each his own. I'm using bond ladders out to 4 years. If rates go up I'll make it up. Currently tips just don't make sense to me except for a minimal position (whatever that is for you)

 

[Curmudgeon]

Thanks. I started buying i-bonds a few years ago, but gave up due to the slow rate of accumulation (10K/SS/yr, as you say), the crummy yields, and the lack of liquidity.

I'll look into the TIPS funds. Though, it seems to me those are generally still subject to rate risk. My broker (TDA) gives me access to TIPS on the secondary market, so I'm not sure of the advantage of a fund or ETF here - there is no need for diversification her, other than maturity diversification, and I can get that with my own ladder.

 

[Curmudgeon]

there are of course other options

Thanks. I started buying i-bonds a few years ago, but gave up due to the slow rate of accumulation (10K/SS/yr, as you say), the crummy yields, and the lack of liquidity.

I'll look into the TIPS funds. Though, it seems to me those are generally still subject to rate risk. My broker (TDA) gives me access to TIPS both at auction and via the secondary market, so I'm not sure of the advantage of a fund or ETF here - there is no need for diversification her, other than maturity diversification, and I can get that with my own ladder.