TIPS held to maturity as "bottom" of cash component?

Discussion of the Cash portion of the Permanent Portfolio

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fnord123
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TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 10:05 am

Ftf: I searched for a similar thread, and found http://gyroscopicinvesting.com/forum/in ... opic=205.0, but I think this proposal is slightly different, so decided to create a separate thread.

The proposal: Hold a small (maybe < 25%) portion of the cash part of the PP in TIPS, with the intent of holding them to maturity.

The reasoning:
  • 75% of ones cash would be in liquid instruments (I-Bonds, FDIC insured savings accounts, short term treasuries, etc.) in case one needs to draw down the cash for rebalancing. Given that one of the key PP attributes is low volatility, the chance of blowing through that 75% in rebalances and having to grab the tips seems quite low.
  • Holding TIPS to maturity means no risk of principal loss
  • TIPS are taxed like interest, but this is no different from short term treasuries, savings accounts, etc.
  • TIPS are available currently with >0% real yield, and will yield more if inflation goes up. 30 year tips have > 2% real return, which is pretty nice!
  • This would only be for someone who plans to hold or contribute to their PP for a long time (the duration of whatever TIPS they buy). For someone in a draw-down mode this isn't a good idea as the 25% TIPS part of the cash would grow as the other cash parts were liquidated, invalidating the first bullet.
Thoughts?
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MediumTex
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 10:25 am

With TIPS, you are buying interest rate risk, principal risk and bad tax treatment.

I understand that if held to maturity the first two risks go away (sort of), but the purpose of the cash component of the PP is to ALWAYS have liquidity and safety in that quadrant of the portfolio.

I just don't like TIPS.

For most investors, though, I-bonds do a great job and I would stick with that if you are wanting to venture outside of ST treasurys.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by AdamA » Fri Jan 28, 2011 10:28 am

It's an interesting proposal...

Curious to hear what some of the more experienced guys on the site think.  

The one think I would I comment on tangentially is that I would not count on the FDIC insured savings account if there's a huge deflation.  I'd want the money in treasuries, and maybe a little underneath my mattress, but I'm probably a little paranoid.  

Adam
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Re: TIPS held to maturity as "bottom" of cash component?

Post by AdamA » Fri Jan 28, 2011 10:29 am

Medium Tex--

Can you expand a bit as to why you like I-bonds?

Thanks,
Adam
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 11:28 am

Adam1226 wrote: Medium Tex--

Can you expand a bit as to why you like I-bonds?

Thanks,
Adam
1. Total deferral of taxes on interest until redemption (up to 30 years)

2. Zero interest rate risk

3. Zero prinicipal risk

4. Full faith and credit of U.S. government

5. Complete liquidity (redeem at the bank on the corner any time you want)

What's not to like?
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Re: TIPS held to maturity as "bottom" of cash component?

Post by moda0306 » Fri Jan 28, 2011 11:33 am

MT,

Why not them over LT bonds then?  Is there some kind I-bond fund one can purchase?  The tax deferral sounds like a sweet deal, but is it priced into the effective interest rate?

And how do they have no interest rate risk?

Curious how these work...
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AdamA
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Re: TIPS held to maturity as "bottom" of cash component?

Post by AdamA » Fri Jan 28, 2011 11:49 am

[/quote]

1. Total deferral of taxes on interest until redemption (up to 30 years)

2. Zero interest rate risk

3. Zero prinicipal risk

4. Full faith and credit of U.S. government

5. Complete liquidity (redeem at the bank on the corner any time you want)

What's not to like?
[/quote]

Forgive the naive question, but why is the interest paid one this greater than a Treasury Bill?  Is it b/c you have to hold for at least a year?
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Re: TIPS held to maturity as "bottom" of cash component?

Post by moda0306 » Fri Jan 28, 2011 11:57 am

Nevermind... read up on them.  Seem like a sweet deal.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by AdamA » Fri Jan 28, 2011 12:14 pm

Moda--

I have read on them, and I think I understand how they work.  The thing is, I can't really figure out how the fixed rate is determined. 

With T-bills, notes, bonds, at least you can compare the rates of various maturities and get an intuitive idea of why they are what they are.  With the Ibond, I'm not sure what to expect. 

Does that make sense?

Adam
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Re: TIPS held to maturity as "bottom" of cash component?

Post by moda0306 » Fri Jan 28, 2011 12:15 pm

I think the fixed rate stays the same for the life of the bond, and the only thing they can adjust is the inflation rate... though I could be wrong.

Sure isn't very "fixed" if it doesn't stay the same.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by AdamA » Fri Jan 28, 2011 12:19 pm

Right, but what am I comparing the Ibond to?  ie, "I can get 2% + interest from the Ibond versus X% for the ? bill/bond/note?"
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 12:19 pm

moda0306 wrote: I think the fixed rate stays the same for the life of the bond, and the only thing they can adjust is the inflation rate... though I could be wrong.

Sure isn't very "fixed" if it doesn't stay the same.
It's a weird methology, but you can't lose your principal and that is what is important for PP cash purposes.
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