Buy TIPS now or wait (No Inflation Data)

[OldShooter]

Of course there is a critical difference between TIPs "insurance" and fire insurance:
AS THE POST YOU QUOTED NOTES: there are many alternative fixed income and equity products that offer greater protection against inflation ---- while there is no serious alternative to paying for fire insurance.
Regards, Dick

Maybe I missed the memo, but I have seen no fixed income products that protect against inflation except to offer higher yields, with buyers left hoping that they are high enough. I guess that is some kind of "protection" but since inflation is not factored into the promise I personally would not use the "protection" word. Maybe "mitigate"? 14% anyone? https://www.federalreservehistory.o...story/FedHistory/Images/great_inflation_2.jpg

 

[big-papa]

Good assessment. The cost of not just a government guarantee BUT ALSO "protection" from inflation is extreme. Whether it makes sense for you to pay that extreme cost in a portion of your portfolio is obviously up to you. But an informed decision requires that the investor understands 1) the mechanism of the inflation compensation offered by TIPs and 2) the consequent taxes and cash flows. It's my opinion that folks who only look at pop articles and the published yields of TIPs can easily make painful choices.
1. TIPs are government securities. Their market prices rise and fall with interest rates. Pull up a chart of TIP that is a portfolio of TIPs. When inflation skyrocketed and Fed tightened '22-'24, TIP FELL from 130 to 105. One can always duck behind "I never sell," but at least observe that the time to buy TIPs at the lowest prices is when inflation PEAKS and falls ---- not before inflation rises. Expected?
2. The coupon rate on TIPs does not change. You are compensated for inflation by additions to the principal, the final payment --- and those dollars are not captured until maturity. But here is the killer:
Imagine a TIP like the current 10 year with a coupon at 1.88%. Let's see what happens when that $100,000 bond gets compensated for (wow!) 5% inflation. This is rough for illustration.
First year (say) 100,000 × .0188 gives you a cash flow of $1880
Second year 105,000 × .0188 gives you $1974, so that year you get an extra $94
BUT BUT BUT you must ALSO pay taxes on the $5000 add-on that year. If you are only in a 12% bracket, your tax will be $600. So your "inflation protecting" TIP caused you to have a NEGATIVE CASH FLOW of $506. Is that what you had in mind or expected?
Regards, Dick

#1 - Correct. The better time to buy TIPS is when yields are higher and prices are lower. But buying when prices are lower is generally a good thing with any investment, if you can manage it. There really have been bad times to bad TIPS, like when yields were negative.
#2 - Which is a great reason to not hold a TIPS ladder in a taxable account.

Cheers.

 

[big-papa]

Maybe I missed the memo, but I have seen no fixed income products that protect against inflation except to offer higher yields, with buyers left hoping that they are high enough. I guess that is some kind of "protection" but since inflation is not factored into the promise I personally would not use the "protection" word. Maybe "mitigate"? 14% anyone? https://www.federalreservehistory.o...story/FedHistory/Images/great_inflation_2.jpg

You didn't miss the memo. TIPS and Series I bonds are the only things that are guaranteed to at least keep up with inflation in close to real-time: TIPS with a short lag due to how refcpi is calculated and I-bonds having to do with how the variable rate is calculated over a 6 month period. Equities, while historically exceeding inflation over long enough timeframes aren't guaranteed to do so over any time period. If a nominal bond and TIPS bond are purchased at the same time and which have the same maturity, only the TIPS bond is guaranteed to generate cash flows that keep up with inflation all the way to the finish line. Whether the TIPS finishes the race ahead or the nominal can not be known with certainty at the start.

 

[dickoncapecod]

You didn't miss the memo. TIPS and Series I bonds are the only things that are guaranteed to at least keep up with inflation in close to real-time: TIPS with a short lag due to how refcpi is calculated and I-bonds having to do with how the variable rate is calculated over a 6 month period. Equities, while historically exceeding inflation over long enough timeframes aren't guaranteed to do so over any time period. If a nominal bond and TIPS bond are purchased at the same time and which have the same maturity, only the TIPS bond is guaranteed to generate cash flows that keep up with inflation all the way to the finish line. Whether the TIPS finishes the race ahead or the nominal can not be known with certainty at the start.

However, it's worth reiterating that TIPs CANNOT provide cash flows that offset the effects of inflation IN REAL TIME. Most of the inflation compensation comes in the form of additions to the principal/final payment, so most of the inflation compensation may be deferred for many years (during which you pay taxes annually on those principal increases).
Regards, Dick

 

[OldShooter]

Worth reiterating, ... Dick, we heard you the first time, and the second time, and the third time ...

 

[Lorenzo]

However, it's worth reiterating that TIPs CANNOT provide cash flows that offset the effects of inflation IN REAL TIME. Most of the inflation compensation comes in the form of additions to the principal/final payment, so most of the inflation compensation may be deferred for many years (during which you pay taxes annually on those principal increases).
Regards, Dick

I'm interested in how this works if you are laddering the TIPS, with TIPS maturing each year.

Regardless, it seems to me the rule of not putting all one's eggs in one basket holds true. Perhaps hold a portion in a TIPS ladder, but don't rely entirely on maturing TIPS for enough cash flow to compensate for inflation of the past one year.

 

[big-papa]

However, it's worth reiterating that TIPs CANNOT provide cash flows that offset the effects of inflation IN REAL TIME. Most of the inflation compensation comes in the form of additions to the principal/final payment, so most of the inflation compensation may be deferred for many years (during which you pay taxes annually on those principal increases).
Regards, Dick

On a per-TIPS basis, this is correct (see my post for the comment about the lag due to how refcpi makes the adjustments) and then adjustments are made daily. And it's also true regarding maturing TIPS. It's also why building an income stream in the form of a ladder is popular, which attempts to spread some of this out - though there are always more individual coupon payments early on when there are still a lot of unmatured TIPS than there are later.

Still, there are practical limitations. At the point that a coupon payment is made (2X per year per bond), it no longer receives inflation adjustments. At the point that a TIPS matures it also receives no additional inflation adjustments. In the next few years, one can have up to 4 TIPS maturing per year, once a quarter, then later, on 3 TIPS then 2, then finally only 1 TIPS maturing per year. Regardless of how many there are that mature per year, most people who do this use something else to buffer the proceeds in order to minimize the short term loss of spending power before actually spending.

To make things simpler, we chose just a single maturity per year: January through 2039 then February from that point on. The first year we had a ladder, I used a nominal fund ICSH. Beginning this year, however, I'm now using the new ultrashort TIPS fund, ICPI from iShares for this. Backtesting with the index it tracks, adjusted for the e/r, shows that for my usage case, it did better than any of nominal ultrashort bond funds or MM's that I looked at, both through the inflation spike a few years ago and on through the recovery. Until there is something like an inflation-indexed T-Bill (don't hold your breath), this will be sufficient for us.

Cheers.

 

[dickoncapecod]

Worth reiterating, ... Dick, we heard you the first time, and the second time, and the third time ...

Perhaps you did, Shooter ! But the gent whose post I responded to had not. To avoid further annoyance, I'll just stop.
Regards, Dick

 

[big-papa]

Perhaps you did, Shooter ! But the gent whose post I responded to had not. To avoid further annoyance, I'll just stop.
Regards, Dick

I did and already knew it before you posted, having owned TIPS for sometime now. I just didn't see the need to respond until you responded directly to my post.

FWIW, it's also worth noting that SS only makes inflation adjustments once per year. And, we manage.

Cheers.

 

[big-papa]

I'm interested in how this works if you are laddering the TIPS, with TIPS maturing each year.

Regardless, it seems to me the rule of not putting all one's eggs in one basket holds true. Perhaps hold a portion in a TIPS ladder, but don't rely entirely on maturing TIPS for enough cash flow to compensate for inflation of the past one year.

See my post above - most people buffer maturing TIPS in something else for spending to help mitigate loss of spending power in the shorter term between maturing TIPS.

I'm currently using the new ultrashort TIPS fund, ICPI, for that. There's another one, that slightly older than ICPI, RBIL, with a higher AUM, but also a slightly higher e/r as well.

Cheers.

 

[OldShooter]

... Regardless, it seems to me the rule of not putting all one's eggs in one basket holds true. ...

To each his own, certainly, but people put their 100% of their eggs in US Treasury bonds all the time and that's exactly what a TIPS is. So I, for one, don't lose sleep over it. YMMV.

 

[Chuckanut]

BUT BUT BUT you must ALSO pay taxes on the $5000 add-on that year. If you are only in a 12% bracket, your tax will be $600. So your "inflation protecting" TIP caused you to have a NEGATIVE CASH FLOW of $506. Is that what you had in mind or expected?
Regards, Dick

Which is why Tips are most often recommended for tax advantaged accounts like an IRA. You left that part out.

And most of people I know who buy TIPS hold them to maturity. If we’re not using a tax advantaged account and/or we aren’t reasonably certain we can hold them to maturity, then we don’t buy them.

They’re a tool to be used by some people to add diversity to one’s investments.

 

[Lorenzo]

To each his own, certainly, but people put their 100% of their eggs in US Treasury bonds all the time and that's exactly what a TIPS is. So I, for one, don't lose sleep over it. YMMV.

@big-papa suggested, in response to the portion of my post that you quoted, having a fund to smooth out the TIPS distributions to address the inflation compensation timing issue that Dick noted.

I can't imagine anyone having "100% of their eggs in US Treasury bonds." How do you pay bills as they come due with 100% in Treasury bonds? I have to believe you did not literally mean 100% and were just trying to make the point that there are people who hold most of their savings in Treasury bonds (including TIPS).

 

[Fermion]

30 year TIPS is getting really close to 3% real. If it spikes to 4% real I am all in.

 

[SJhawkins]

30 year TIPS is getting really close to 3% real. If it spikes to 4% real I am all in.

As of now I happy with our ladder of TIPs to SS but have to admit I'm been thinking about extending the ladder if the "right deal" comes along, yeah it's market timing in some ways........I had the same 4% as time to buy, seems reasonable.

The current rates are not terrible really either, most likely will buy some more. Looking to be done with W2 income in the very near future. Given the current market highs dialing the AA back by 5% to 60/40 is tempting too. That would probably add 8 years post SS.

 

[Trailwalker]

As of now I happy with our ladder of TIPs to SS but have to admit I'm been thinking about extending the ladder if the "right deal" comes along, yeah it's market timing in some ways........I had the same 4% as time to buy, seems reasonable.

The current rates are not terrible really either, most likely will buy some more. Looking to be done with W2 income in the very near future. Given the current market highs dialing the AA back by 5% to 60/40 is tempting too. That would probably add 8 years post SS.

I'm in the same place, but 30 years is longer than my comfort zone. I'm watching to see if the 5 year climbs over 2 percent and the ten year closer to 2.5%. If it doesn't happen, I'll probably stick where I'm at. TIPS were mainly a vehicle for me to sleep well at night and provide an income base to get past SORR. My last TIP will mature when I'm about 70.

 

[tulak]

I stick with 10 year TIPS and buy during the January auction.

I have a full ladder at 10 years and will likely keep buying for the next few years. Not sure when/if I’ll stop. Everything else is invested in equities, so it’s good to have some investments in fixed income.

 

[Fermion]

I sold $200,000 of the 30 year TIPS after holding them for a week. Made a little over $2,000 but looks like could have made a bit more since rates are dropping over the weekend. I kind of love the trade because I don't mind getting "stuck" with 2.9% real but if the volatility is willing to give me a 60% annualized return I am going to take that every time.