As I understand it, the offer yield-to-maturity is the yield you will get on the actual dollars you use to buy the TIPS, but it does not include future interest increases due to inflation indexing.
Not really. The YTM may understate the income you'll actually receive. A bond paying 3.875%, for example, may have a YTM of 2.5% but a current yield of ~3.1%. IOW, you'll get an income of 3.1% of your purchase price. However, there's no free lunch, so you'll get commensurately less in the end.
And I think the money you get back at maturity is the same dollar amount as anyone holding those particular TIPS will get -- in other words, the original cost, plus accrued inflation as defined by the CPI.
You won't get
your original cost back (plus inflation), unless you buy at par. Since you pay a premium for a much higher yielding bond on the secondary market (than can be purchased directly at auction), the principal amount of the bond you bought is actually less than you paid, sometimes far less. That's the amount of principal you're starting with - NOT what you paid. As you hold the bond over the years, the principal will be adjusted upward as the CPI increases, but remember that the amount that is being adjusted upward (or downward in deflation) starts out as quite a bit less than you paid. On the other hand, you're getting 3.875% of that smaller principal amount, which is WAY more than the market is currently paying (in my case that came to ~3.1% of the amount that I actually paid for bonds that had a YTM of 2.5%). So:
-- I start with less principal than what I paid
-- but I get more income as I go (3.1% of what I paid vs. the 2.5% I would have received if I had bought at par -
which I couldn't have done at the time since they had stopped selling 30 year TIPS)
-- and in the end I get less back than if I had bought the bonds at par, because I started out in the hole due to the premium I paid.
-- But when it's all said and done, I end up with the same yield to maturity, 2.5%, that I would have received if I had bought at par through Treasury Direct (
if it had been possible to do so at the time). I just chose to receive more income in exchange for less principal in the end.
Yes, the principal does keep pace with inflation, but if you pay a premium for the bond, you start out with a principal amount that is less than you actually paid. The YTM is the most important number because it defines what you're actually getting in real dollars, ALL things considered. But if you want to know the amount of the "real" income you'll receive, based on your purchase price, you look for the "current yield", not the YTM. Just remember that when the current yield is higher than the YTM, you'll get less back in the end - there's no free lunch. I prefered to do it that way because it reduces the need to sell bonds as I go which 1) removes most market risk from the equation if I hold to maturity, and 2) eliminates the brokerage fees that would have accompanied those sales.
It's getting late - I don't know if any of this makes sense, but I'm sure someone will correct me where I'm wrong, or do a better job of describing it than I'm doing.
