@pizzaman May I suggest we take this discussion of TIPs off-line? Email me kandell@gmail.com
@jkandell I'm enjoying the TIPS conversation. Perhaps this isn't the correct venue or section for the discussion but it is edifying to all of us that lurk here. Maybe migrate it to a new thread with TIPS in the subject line? That's my 2-cents ????
@boomdaddy3 Ok, I'll continue to respond to Pizzaguy here, then. 🙂
1) Yes, there are dangers in buying individual bonds that might need to be sold on the secondary market prior to maturity. You can't tell what interest rate you'll get. So I only buy individual bonds I intend to hold till maturity. Of course that goes equally for TIPs as nominal treasuries. For monies I might need prior to maturity I use Bond mutual funds of similar duration (nominal and TIPs).
2) Yes, there can be a slightly larger bid-ask spread in the secondary market for TIPs than ordinary treasuries. That's why I try to buy TIPs at the treasury auction: it's easy and you get the price paid by the largest buyers, with a very small spread. It's a sweet deal the govt has deliberately set up for the "little guy"!
3) The "break even inflation" rate is a useful concept to show how much inflation it would take to break-even with the TIP. The formula by the way is (1+nominal treasury yield) / (1+ TIP yield) -1. I think of it as the "cost" of the inflation insurance afforded by TIPs I am purchasing. The breakeven rate is also a common method of estimating future inflation in modeling. Some people split the difference, with half their bond allocation in nominal bonds and half in tips.
I'm not saying they're for everyone. But as someone who is close to retirement expected inflation is one of my biggest risks (though not the only one of course). When one is working, salaries are roughly tied to inflation. Social security when I claim it is roughly tied to inflation. Stocks are somewhat related. But bonds are not! (I lost a lot of money in CDs during the last couple years from unexpected inflation.) And since my essential expenses are covered by mostly bonds, I elect to go for the extra protection of TIPs. With the deficit and political unknowns, I feel inflation is a real concern for funds I'll need to cover essentials a few decades away. I think of it as a private inflation-protected pension.
So the interest rate paying out this 6 month period is 4.45% is that correct??
What you're describing is closer to i-bonds, where the interest rate itself goes up and down with inflation. With TIPs the interest always stays the same. (Whatever the coupon is.) What changes with inflation with TIPs is the principal (which is different from how nominal bonds work), every six months. So at maturity you don't get your principal back; you get your principal that's been adjusted for inflation all along the way. And of course you've been paid coupons every six months. It's an odd way they've chosen to do it, but in the end it amounts to the same amount of $, I think.
My favorite site for explaining the nitty gritty of TIPs is tipswatch.com. A good site for coming up with a ladder is tipsladder.com. Many people prefer TIPs mutual funds instead of individual TIPs bonds. (Vanguard's Target Retirement Inflation fund is 17% short-term TIP mutual fund, for instance.) I have those too. But as I mentioned, after my experience a few years ago where my BND lost 17% and hasn't yet recovered, I prefer the certainty of individual bonds held to maturity over the unknowns of a mutual fund for monies that I absolutely need for essential expenses not covered by social security.
If you haven't seen it, I highly recommend looking at the tpaw simulator for the safety first approach we take. (And, yes, it includes bootstrapping.)
Just wanted to say thanks for mentioning this. I wasn't aware of this tool. It's a great sanity check on my Pralana outcomes.
Todd
@jkandell Thanks for sticking with this thread, I am learning a lot! I found a web site that goes into great detail on TIPS, it clarifies several things for me:
https://moneyfortherestofus.com/tips-and-ibonds/
@pizzaman Cool. One final thought: I never touched TIPs back when they had yields of close to 0%. I-bonds were a better deal (and both were a better deal in retrospect than nominal CDs/bonds). But TIPs yields have been excellent lately, as high as 2.6% real (recent 30y), 2.3% (10/20y).
