Another TIPS question

That’s for sure! It seems straightforward on the surface, but it’s quite complex.
I think TIPS can be understood at a fairly simple level. Maybe just focus on the maturity date and the real yield to maturity. Digging a little deeper one might want to know a few more things like that the total value is dependent on the inflation factor as it increases over time to maturity.

Anyway, I have found the Vanguard bond desk reps are able to answer some simple TIPS questions. So there is a way of getting more educated if desired.
 
It is complicated. Not being an experienced bond trader or even treasury buyer, I think I should stay away for now. Just not certain which TIPS to purchase and if it’s a decent value bet.
I’ve recently sold a significant amount of stock to rebalance to my more preferred levels. Sitting in money market now earning low 4%. Maybe I’ll investigate regular treasuries as they should be a little more straightforward to figure out (I think?).
I’ll keep trying to understand TIPS and follow along on posts about them. But for now, I’ll just hold off.
 
I look at TIPS this way. I chose a 5 year time horizon and found a UST and a TIPS that mature around then.

UST TIPS 912810FH6 matures 4/15/29 3.875% coupon trading at 108.55469 yielding 1.767%

UST 91282CEM9 matures 4/30/29 2.875% coupon trading at 94.07227 yielding 4.411%

The YTM difference implies the market is pricing in an average of 2.644% inflation between now and April 2029. That seems very plausible to me. If I buy the TIPS instead of the Treasury and inflation exceeds 2.644% then I come out ahead, if inflation is less than 2.644% then I would have ben better off with the UST. Pick your poison.

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I look at TIPS this way. I chose a 5 year time horizon and found a UST and a TIPS that mature around then.

UST TIPS 912810FH6 matures 4/15/29 3.875% coupon trading at 108.55469 yielding 1.767%

UST 91282CEM9 matures 4/30/29 2.875% coupon trading at 94.07227 yielding 4.411%

The YTM difference implies the market is pricing in an average of 2.644% inflation between now and April 2029. That seems very plausible to me. If I buy the TIPS instead of the Treasury and inflation exceeds 2.644% then I come out ahead, if inflation is less than 2.644% then I would have ben better off with the UST. Pick your poison.

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Considering the 2.644% in your example above. Is the relevant number what inflation is at maturity? Or is it the cumulative inflation over the course of the life of the TIPS? IOW, are you betting on what inflation is at a point in time (4/15/29), or on the inflation rates between now and 4/15/29?
Thanks. Like I stated. I’m still trying to understand some of the basics.
 
I decided to dip my toes into the TIPS world by participating in the auction next week. I put in my buy order with Schwab today for the 10-year issue. I want to see how it shows up in my listing of holdings within my IRA and want to figure out how I'll model it in Quicken. If I like what I see, then I might start building more of a ladder. But I think I would do that over time using future auctions rather than purchases on the secondary market. I've done all my T-Bill purchases at auction and I like the "cleanliness" of that process. Secondary markets are a foggy topic to me still.
 
Considering the 2.644% in your example above. Is the relevant number what inflation is at maturity? Or is it the cumulative inflation over the course of the life of the TIPS? IOW, are you betting on what inflation is at a point in time (4/15/29), or on the inflation rates between now and 4/15/29?
Thanks. Like I stated. I’m still trying to understand some of the basics.
It is the cumulative inflation. You can look at the inflation factor at time of purchase but this changes as time goes on. At maturity you get back the number of TIPS purchased times the inflation factor.
 
That’s not right.

For TIPS bought on the secondary market, you can easily pay more than par due to the inflation adjustment. You will get this back, assuming there is no deflation.

For example, if the inflation adjustment is 1.1 and you buy a par 1k TIPS, you’ll pay 1.1k and will receive that amount back if the inflation adjustment stays at 1.1 until maturity. That would be the scenario with no inflation. If there’s inflation, then the inflation adjustment goes up, and the inflation adjustment goes down if there is deflation.

Deflation is the only risk you have if you pay above par, since TIPS will always return a minimum of par at maturity.
Thanks.

So while there is less chance of not getting back all a person paid, than I had thought which is good.
It is still there due to deflation.

Seems like when a person pays the 1.1K , that they are paying the person who had it prior, and then hoping inflation stays above 0%.

I think it would be true there is less risk of this deflation effect upon TIPS bought at auction.
 
I just placed an order for the 10yr TIP , as I believe inflation will remain with us over 2%.

I'm viewing the TIP bonds as insurance in case we get rising inflation.

Now I just have to live another 10 yrs to see if it was a good idea :)
 
Considering the 2.644% in your example above. Is the relevant number what inflation is at maturity? Or is it the cumulative inflation over the course of the life of the TIPS? IOW, are you betting on what inflation is at a point in time (4/15/29), or on the inflation rates between now and 4/15/29?
Thanks. Like I stated. I’m still trying to understand some of the basics.

Its the annualized cumulative inflation. In other words, the average annual inflation rate between now and maturity. But note that the average is taken in a CAGR fashion, i.e., (1 + total inflation over 5 yrs)^(1/5) -1.
 
Considering the 2.644% in your example above. Is the relevant number what inflation is at maturity? Or is it the cumulative inflation over the course of the life of the TIPS? IOW, are you betting on what inflation is at a point in time (4/15/29), or on the inflation rates between now and 4/15/29?
Thanks. Like I stated. I’m still trying to understand some of the basics.
It is over time... from purchase to maturity. Each period the par value... the principal that you will receive at maturity... increases for inflation for that period plus you get the 2.875% coupon payment in cash.

You can think of the inflation adjustment as a kicker for inflation that is reinvested like a reinvested dividend on a stock. After the kicker you have more par value just like after the reinvested dividend with a stock you have more shares.

So your income is two pieces: 1) interest that you received in cash at the coupon rate on the par value and 2) increases in the par value for the inflation adjustment that you can only get at maturity.

The YTM shown is for the first part. The YTM is lower than the coupon because the TIPS is trading at more than 100. The second part above, the inflation adjustment isn't included because it is unknown.
 
Another thing to keep in mind is that you are taxed on both the interest received each year as well as the inflation adjustment each year, as it's reported income, even though you don't receive an actual payment on the inflation adjustment during those years. So, you aren't deferring the income like you are with I-Bonds. And don't forget to claim the accrued interest that was paid at purchase when you are able to as a negative entry on Schedule B to offset interest income from the same TIPS issue.
 
Another thing to keep in mind is that you are taxed on both the interest received each year as well as the inflation adjustment each year, as it's reported income, even though you don't receive an actual payment on the inflation adjustment during those years. So, you aren't deferring the income like you are with I-Bonds. And don't forget to claim the accrued interest that was paid at purchase when you are able to as a negative entry on Schedule B to offset interest income from the same TIPS issue.
You are referring to TIPS held in a taxable account. They are better to hold in a retirement account if you have the space to do so. Then the "phantom income" is not a consideration.
 
You are referring to TIPS held in a taxable account. They are better to hold in a retirement account if you have the space to do so. Then the "phantom income" is not a consideration.
Yes, I have them in both types, but it only takes one in a taxed account for it to come into play. Hopefully people know which type they have. lol In my case, it resulted in higher MAGI than I would have liked when combined with the CD's and higher interest rates that I later purchased, which was relevant in my case due to ACA costs tied to MAGI income, and I am near a threshold.
 
I want to thank those who replied. Your patient responses are appreciated. If I’m not careful, I may actually start understanding these instruments. Feel as though I’ve learned a lot from y’all.
 
Suppose I buy TIPS on the secondary market and they are listed as a yield to maturity of 2%. The coupon could be some other value like 0.5%. That real 2% yield then does not just come from the coupon, no?

EDIT: I just happened now to be looking up a TIPS maturing in Jan 2030. It was issued in Jan 2020 and has a yield to maturity of 1.94%. The coupon is only 0.125.

P.S. I do not consider myself a TIPS expert and don't mind admitting it. If I make mistakes in posts I want to hear from you. I think humility in these matters is good. :)
I am also no expert and only recently have I ventured into the world of bonds and TIPS.
Always willing to learn!

This is my understanding:
The yield to maturity comes from a combination of the discounted price and the coupon rate.

If you buy a bond at par value, Yield to maturity (YTM) exactly equals coupon rate.

If you buy a bond at 50% par value with 20 year maturity and zero coupon rate, the YTM will be 3.5%.

Yield calculations can be made with the YIELD function in Excel.
 
QG67PK00, are you forgetting to include the inflation factor for TIPS? That will be key in determining how much your TIPS are worth at maturity. The inflation factor compounds as we move toward TIPS maturity.

I asked ChatGPT how to use the YIELD function to calculate using TIPS. Here is an example it spit out:

Assume you have a TIPS with a face value of $1,000, a coupon rate of 1.5%, a maturity of 10 years, and the current CPI adjustment factor is 1.03.

  1. Adjusted Principal: $1,000 * 1.03 = $1,030.
  2. Current Market Price: Suppose it's trading at 101% of the adjusted principal = $1,030 * 1.01 = $1,040.30.
  3. Calculate Yield:
    =YIELD(DATE(2023,1,1), DATE(2033,1,1), 0.015, 104.03, 100, 2, 1)
In the example the inflation factor was only 1.03. More typically it is much higher for several years of inflation.
 
QG67PK00, are you forgetting to include the inflation factor for TIPS? That will be key in determining how much your TIPS are worth at maturity. The inflation factor compounds as we move toward TIPS maturity.

I asked ChatGPT how to use the YIELD function to calculate using TIPS. Here is an example it spit out:


In the example the inflation factor was only 1.03. More typically it is much higher for several years of inflation.
Per my understanding:

For TIPS, the YIELD calculation gives you the Real Yield, i.e. yield after inflation is factored in.

In your example calculation above, the real yield will be 1.07%. The actual (nominal) yield will depend on the future inflation.

Nominal yield on TIPS = Real Yield (known upfront) + current Inflation.

For a regular bond, the YIELD calculation will give you the Nominal Yield. The Real Yield for a nominal bond will vary with inflation rate over time.

Real Yield on regular bond = Nominal Yield (known upfront) - current Inflation.
 
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Not quite right. Yes you get the coupon which needs to be reinvested at the current rates, but the real reason you invest in TIPS is because you get a REAL rate of return above inflation. If inflation runs 2.5% and the TIPS you buy have a yield to maturity of 2.0% then you should get 4.5% on your investment.

Not a get rich scheme but better then just mere preservation of purchasing power.

It's been a busy week, so I'm late to responding to this, but I've been thinking about the bolded since I read it earlier in the week.

This is not why I buy TIPS, but it is a nice bonus. I invest in TIPS because they guarantee an inflation adjusted return of principal at maturity. I consider this to be insurance to deal with SORR and eventually, having to sell equities in a down market for needed income.

I have the following requirements for fixed income:

1. No loss of principal.
2. Return of inflation adjusted principal when I need the income.

The other requirement I have is to maximize my portfolio return, by investing the maximum I can in equities, while dealing with SORR.

I wrote a longish thread on this a couple of years ago, which can be found here: AA with TIPS for FI

Basically, I modeled an equity/fixed income portfolio using only TIPS for fixed income and found that it had better portfolio survivability than using other fixed income investments. I created my own simulation to model this - similar to Firecalc - which I describe in that post. The best part was, I didn't consider any coupon rate for TIPS. I assumed 0% and only modeled TIPS based on the inflation adjustment (CPI), which you can backtest since CPI data is available back to 1913. If I was to add in the coupon rate, portfolio survivability would be even better, but that is a lot harder to model, since TIPS haven't been around that long.

I wish there was more research in this area. I was surprised there's no papers or blogs posts writing on the use of TIPS for fixed income and looking at portfolio survivability compared to other fixed income investments. If I had more time (and energy) I wouldn't mind doing this myself, especially since it would help confirm my findings. There's always the chance that I haven't modeled it correctly or my assumptions are wrong, but I spent enough time looking at it that I feel comfortable with my results.
 
I think it is fine if one just wants an inflation adjusted return of principle i.e. would settle for even 0% real yield. If one looks at the TIPS yields since 2003 there were significant periods of time where TIPS paid negative yields to maturity (select MAX here: 5yr FRED TIPS chart). I would not go for that deal.

Personally I'm greedy and want a historical real rate of return for my bond holdings. That would be in the 2% neighborhood. Now is a good time for TIPS.
 
TIPS never have a negative coupon rate. If you buy at auction and hold to maturity, you will always get at least your principal back, even if there is deflation

CPI was increasing since 2003+, so you would have had at least the inflation gain, even with a low coupon rate.

I’m greedy too, which is why I invest heavily in equities and take my risk there, instead of chasing 2% real yields.
 
That FRED chart I linked to shows negative yields to maturity in the past.
 
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So for the TIPS experts, I have two questions. If I were to buy this above par TIPS then at maturity would the payout be adjusted by the "factor" effective at the time? Is this accounted for in the YTM or does that just consider the income stream?
tips above par.png
 
I think the final value of your holding would be: #_TIPS * inflation_factor_at_maturity
The YTM would be calculated as per the example (from ChatGPT) I showed above. That inflation_factor would be the one at time of the TIPS purchase since, of course, the inflation factor at maturity is not known.

Caveat: I am no expert on this stuff. If you want some really more reliable answers you can sign up with TIPS WATCH and ask there. The author regularly answers questions.
 
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