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

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

Post by MediumTex » Fri Jan 28, 2011 2:44 pm

I-bonds are also a good way of teaching your kids about money.

I showed my daughter an I-bond and told her that if I put it in a drawer for 20 years it would be worth a lot more than it is today. 

I then showed her some currency and told her that if I put it in a drawer for 20 years it would be worth a lot less than it is today.

I then showed her a silver eagle coin and told her that if I put it in a drawer for 2000 years it would basically be worth the same as it is today.

She looked at me quizzically.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 2:48 pm

fnord123 wrote: Well bleh, my TIPS thread has been hijacked into an I-Bonds discussion.

I-Bonds are great for all the reasons mentioned. They also are limited to $10K/year investment.  So assume somebody has $40K in the cash segment of their PP.  They could go get $10K in I-Bonds (5 online, 5 paper). Great. Now what about the remaining 30K?
If you're married your spouse can do another $10,000.

In 11 months you and your spouse can do it again. 

Problem solved.

I think that for most people the I-bond limits are really not that problematic.  For a couple working together, in only a few years you could have a pretty large amount of I-bonds.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 2:54 pm

MediumTex wrote: I-bonds are also a good way of teaching your kids about money.

I showed my daughter an I-bond and told her that if I put it in a drawer for 20 years it would be worth a lot more than it is today. 

I then showed her some currency and told her that if I put it in a drawer for 20 years it would be worth a lot less than it is today.

I then showed her a silver eagle coin and told her that if I put it in a drawer for 2000 years it would basically be worth the same as it is today.

She looked at me quizzically.
Given that the I-Bond tracks the CPI-U, with zero additional interest (at least for I-Bonds one can buy today), and that CPI-U is at best tracking inflation (and many people argue understates inflation), won't the I-Bond at best be worth about the same as it is worth today in terms of purchasing power?  So other than less volatility risk (but additional risk in terms of understating true inflation), the I-Bond seems similar to the silver eagle.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 2:54 pm

fnord123 wrote: My thought was to put a portion of that $30K (let's say, $10K) into TIPS and hold to maturity.  If I understand correctly, the tax treatment here is identical to the tax treatment that short term treasuries get, so that isn't an argument against TIPS, is it?

Is the anti-TIPS sentiment the idea that someone will need all of their cash segment (not just 75% of it) fully liquid?  The only possible scenario I can come up with for that is if the other 3 segments (gold/LT treasuries/stocks) drop to something like 10% of their value and one needs to rebalance 80%+ of the cash in their cash segment into the other segments.  For that to happen, the S&P 500 would need to hit 130, gold $130/ounce, and 30 year treasury interest rates would need to be something like 0.2%.  Is the economy even functioning at that point?  Or is there some other scenario I am missing?
Why TIPS, though?

Do you think the CPI is about to explode?

If you had no other options, then I would say sure, buy the TIPS and hold to maturity.  With other options available, though, it just makes TIPS that much less appealing to me.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 2:58 pm

fnord123 wrote: Given that the I-Bond tracks the CPI-U, with zero additional interest (at least for I-Bonds one can buy today), and that CPI-U is at best tracking inflation (and many people argue understates inflation), won't the I-Bond at best be worth about the same as it is worth today in terms of purchasing power?   So other than less volatility risk (but additional risk in terms of understating true inflation), the I-Bond seems similar to the silver eagle.
In 2000 years an I-bond will be long burned, soaked, torn up or thrown away.

An I-bond is just a piece of paper.

The silver has a much better chance of hanging around and still being valued by people.

My point was more about the transitory nature of human institutions than about whether I-bonds accurately track inflation.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 3:05 pm

MediumTex wrote:If you had no other options, then I would say sure, buy the TIPS and hold to maturity.  With other options available, though, it just makes TIPS that much less appealing to me.
What are the other options?

I-Bonds have positive attributes, I agree.  The main negative attribute (other than the annoying per-year limit) is that the I-Bonds people can buy today give 0% interest above CPI-U.  That stinks.  Here's a TIPS bond listing from Vanguard that is for sale right now - these are the 20 year bonds issued a couple years back:

CUSIP - Issue - Coupon - Maturity - Price - Yield
912810PV4 - T Tips (Tips) -1.750 - 01/15/2028 - 99.886719/100.199219 -1.758/1.736

So one could take $10,019.92 dollars, and buy these TIPS, that have 1.750% coupon (plus CPI-U).  If held 17 years there is all of $19.92 in principal risk (0.19%), but there is a 1.75% higher coupon than current I-Bonds.  That is pretty hard to beat imo, even if you factor in taxation.  Am I missing something?
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 3:13 pm

fnord123 wrote:
MediumTex wrote:If you had no other options, then I would say sure, buy the TIPS and hold to maturity.  With other options available, though, it just makes TIPS that much less appealing to me.
What are the other options?
You could buy Series EE savings bonds.    8)

They will double in value in 20 years, which guarantees you a return of at least 2.35% or so.

Given the choice of TIPS or regular treasurys, though, I would just go with the regular treasurys.

In fact, if you are willing to buy a 20 year TIPS bond and hold it until maturity and treat this as a cash holding in your PP, why not just buy a 20 year treasury bond right now and hold it until maturity?  That will pay you 4% or so.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by AdamA » Fri Jan 28, 2011 3:20 pm

The five year Treasury is at 2%.  You could consider that.  Easier to hold to maturity (shorter term), and better for tax purposes. 
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Re: TIPS held to maturity as "bottom" of cash component?

Post by Lone Wolf » Fri Jan 28, 2011 3:27 pm

Adam1226 wrote: I am a bit skeptical of the government issuing inflation protected anything.  It's kinda the fox guarding the hen house.  They can easily manipulate the CPI (no food or energy??!!), and you might not get true inflation protection, certainly not what you get with gold (which responds not only to inflation, but also the fear of inflation).
This is absolutely true.  However, from what I understand, I-bonds use the "CPI-U" metric for I-bonds, which does include food and energy.  The "Core CPI" measure excludes food and energy, and this is the one that Federal Reserve chairmen like to use to reassure everyone that inflation is under control.

That being said, you are 100% right to be skeptical of CPI calculations.  The methodology was changed circa 1990 and could be changed again.  The government can save itself a lot of money when it comes time to pay off TIPS investors by taking another look at how the CPI is calculated.  Thus my overall expectation is that the real purchasing power of even the I-bond is likely to erode a bit over time (although much more slowly than other cash instruments.)
fnord123 wrote: Well bleh, my TIPS thread has been hijacked into an I-Bonds discussion.
Sorry about that.  It amazes even me the things I can get excited talking about.

How far out on the yield curve were you thinking of venturing out?  30 years is a mighty long time when you plan to hold to maturity.  With 75% of your portfolio invested and not highly liquid, I like the idea of having 25% of the portfolio with relatively high "agility" if I need to make a big purchase.  If you find yourself needing to spend that money, you suddenly are on the hook for the interest rate risk.

Or were you maybe thinking something more along the lines of 5 years or 10 years?  That seems like much less of a scary commitment than 30 years.  That seems plenty workable, especially if you've bought all the I-bonds you can buy, maxed HSA, etc.  You are probably the best judge of how liquid your cash portion needs to be.

I'm much more amenable to the idea of TIPS in the "cash" slice than I am TIPS in the "gold" slice (something people so often find themselves wanting to do.)
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Fri Jan 28, 2011 3:43 pm

Lone Wolf wrote: I'm much more amenable to the idea of TIPS in the "cash" slice than I am TIPS in the "gold" slice (something people so often find themselves wanting to do.)
Remember that sign on the wall of the guitar shop in "Wayne's World" that said "NO STAIRWAY"?  When Wayne started playing "Stairway to Heaven" the guy in the store stopped him and pointed to the sign.

I would like to put up a sign in this forum with something similar about not substituting TIPS for gold in the PP.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 3:51 pm

MediumTex: I agree that TIPS for gold is a horrible idea. TIPS and gold are not at all correlated with one another and do not represent the same risks or upside at all.

LoneWolf: The suggestion of holding some medium-dated treasuries to maturity in the "bottom" portion of the cash segment seems like an interesting alternative to TIPS.  I'm going to have to go off and look at some yield curves. Thanks for the idea!
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Re: TIPS held to maturity as "bottom" of cash component?

Post by Lone Wolf » Fri Jan 28, 2011 4:12 pm

fnord123 wrote: LoneWolf: The suggestion of holding some medium-dated treasuries to maturity in the "bottom" portion of the cash segment seems like an interesting alternative to TIPS.  I'm going to have to go off and look at some yield curves. Thanks for the idea!
Yeah, that seems like a pretty good way to go (although the credit for that one goes to Mr. MediumTex and\or adam1226!)  I'd be interested in hearing what you find.  Ultimately, that approach does bear interest rate risk as well.  It's hard to find the free lunch unfortunately.

Also, since TIPS have such craptastic tax treatment, would your plan work better if you can squeeze some extra space out of your tax-deferred accounts?  The thing that I really hate about TIPS is that you pay tax immediately on the principal increase due to inflation even though you don't get that money until the security matures, kinda like some sort of zero-coupon bond.  All based on inflation that the government causes and measures itself!

I find myself kind of unable to think straight about TIPS because this particular tax "feature" makes me so upset.  :)

Edit: Clive's idea also strikes me as a very interesting one.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 4:47 pm

Lone Wolf wrote: The thing that I really hate about TIPS is that you pay tax immediately on the principal increase due to inflation even though you don't get that money until the security matures, kinda like some sort of zero-coupon bond.  All based on inflation that the government causes and measures itself!
Whoops - I didn't realize this part.  TANSTAAFL!

Just curious - if the principal goes down (due to deflation) does that act as an offset to other income earned during the same year?  I.e. if someone earned $50K in income, but their tips went down $5K in principal, would they then report $45K AGI on their year-end taxes?
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 5:15 pm

fnord123 wrote:If the principal goes down (due to deflation) does that act as an offset to other income earned during the same year?  I.e. if someone earned $50K in income, but their tips went down $5K in principal, would they then report $45K AGI on their year-end taxes?
So I poked around in the IRS forms a big (publication 1212 in particular).  Looks like principal reductions can be used to offset the TIPS 1099 interest at least.  What isn't clear is if a deflation-driven yearly principal reduction can apply to interest income from other things the invest holds. I'm betting the answer is no, but cannot find anything clear about it online :(
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 5:34 pm

fnord123 wrote:If the principal goes down (due to deflation) does that act as an offset to other income earned during the same year?  I.e. if someone earned $50K in income, but their tips went down $5K in principal, would they then report $45K AGI on their year-end taxes?
So I poked around in the IRS forms a big (publication 1212 in particular).  Looks like principal reductions can be used to offset the TIPS 1099 interest at least.  What isn't clear is if a deflation-driven yearly principal reduction can apply to interest income from other things the invest holds. I'm betting the answer is no, but cannot find anything clear about it online :([/quote]
Yeesh, ok, 2nd answer to my own questions - from form 1212:
Net negative adjustment. A net negative adjustment exists for a tax year when the total of any negative adjustments described in (2) above for the
tax year is more than the total of any positive adjustments for the tax year. Use a net negative adjustment to offset OID on the debt instrument for the tax year. If the net negative adjustment is more than the OID on the debt instrument for the tax year, you can claim the difference as an ordinary loss. However, the amount you can claim as an ordinary loss is limited to the OID on the debt instrument you included in income in prior tax years. You must carry forward any net negative adjustment that is more than the total OID for the tax year and prior tax years and treat it as a negative adjustment in the next tax year.
From reading this gobbledygook, it seems like for a held-to-maturity TIPS bond, one would actually be no more tax-disadvantaged than one would be with a regular treasury held to maturity.  If the net inflation was positive for the TIPS bond when held to maturity, one would realize the "phantom" income as real income when selling the bond.  If the net inflation was negative for the TIPS bond when held to maturity, one would get to deduct the negative OID years as losses, essentially causing phantom income to go to zero in terms of tax payments over the long run, and would get the face value of the TIPS bond back at the end anyway.

The above matches the sentiment I've seen on TIPS over at Bogleheads, where several posts seemed to say that over the long run TIPS are no better or worse than regular treasuries in terms of tax treatment.

I am not a lawyer or accountant, so I could be completely wrong. Hopefully if I am someone will point out where :)
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Re: TIPS held to maturity as "bottom" of cash component?

Post by Lone Wolf » Fri Jan 28, 2011 6:49 pm

fnord123 wrote: The above matches the sentiment I've seen on TIPS over at Bogleheads, where several posts seemed to say that over the long run TIPS are no better or worse than regular treasuries in terms of tax treatment.
I see where you're coming from.

I view the fact that I get taxed on interest payments that I do not (yet) receive as immediate taxation on deferred income.  Basically, I have to pay out from my liquid cash reserves to support securities that will only pay me 5, 10, 20, or 30 years later.  From your view, though, the TIPS are just a part of your cash pile that you are committed to holding until maturity.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Fri Jan 28, 2011 7:21 pm

The immediate taxation on deferred income is obnoxious, I agree with you about that.

I guess I need to evaluate that obnoxiousness (and pulled forward tax burden) versus the warm'n'fuzzy feeling of CPI-U indexing.  I realize CPI-U is a flawed metric, but it seems better than nothing in terms of providing a bit of inflation protection in the cash part of the PP.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by moda0306 » Sun Jan 30, 2011 12:19 pm

The way I see it, the tax piece is simply icing on the cake.  The point is with I Bonds is that, for some reason, they offer better interest rates than 1 year treasuries (sometimes even close to 5-year), and you only have to hold them for a year... if that changes, you get rid of them and buy treasuries... it's that simple.  Yes, you have to hope that the inflation payments are sufficient for 1 year to beat the treasuries, but historically these things have returned extremely well.

It's most likely a slightly subsidized savings vehicle for the middle-class (hence the 5/10k per year limits), so why not take advantage?
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Sun Jan 30, 2011 1:38 pm

moda0306 wrote:It's most likely a slightly subsidized savings vehicle for the middle-class (hence the 5/10k per year limits), so why not take advantage?
In general, I agree, and have several year's worth of I-Bonds in the cash component of my PP.

However, the current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by MediumTex » Sun Jan 30, 2011 1:42 pm

fnord123 wrote: However, the current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.
I-bonds are re-priced twice a year.  Perhaps the May re-pricing will have a higher fixed rate than zero.

I wouldn't buy any with a fixed rate of zero either.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by Lone Wolf » Sun Jan 30, 2011 7:19 pm

fnord123 wrote: However, the current I-Bonds have a non-inflation component of 0%, which stinks.
What is up with this, by the way?  I've been hoping that the I-bond fixed rates for the 2nd half of the year will be better but I simply don't know how these are decided.  For all I know, Treasury may just decide that they hate these things and leave them at 0% forever.

I was thinking about still buying them at 0% if the 2nd half of the year is no better.  With the potential to use them for education tax-free, I'd still been thinking they were worth getting.  But at 0% fixed it does feel like kind of a sucker's play.  What a pity.

The rates for EE bonds are also horrible at the moment so the options for cash aren't as "cool" right now as they have been in the past.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by Pkg Man » Sun Jan 30, 2011 8:25 pm

Lone Wolf wrote:
fnord123 wrote: However, the current I-Bonds have a non-inflation component of 0%, which stinks.
What is up with this, by the way?  I've been hoping that the I-bond fixed rates for the 2nd half of the year will be better but I simply don't know how these are decided.  For all I know, Treasury may just decide that they hate these things and leave them at 0% forever.

I was thinking about still buying them at 0% if the 2nd half of the year is no better.  With the potential to use them for education tax-free, I'd still been thinking they were worth getting.  But at 0% fixed it does feel like kind of a sucker's play.  What a pity.

The rates for EE bonds are also horrible at the moment so the options for cash aren't as "cool" right now as they have been in the past.
I bought I and EEs in two batches.  The I bonds purchased mid2010 had a small but positive fixed rate, while the latter ones had zero.  I still purchased them as compared to a 1 year T-bill the rate was higher (due to the inflation component).  As rates begin to rise I will likely redeem them and just pay the 3-month interest penalty.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by pplooker » Wed Feb 09, 2011 5:16 pm

Wow, you're all much more sophisticated about I bonds than I am.  I just buy a certain amount every X number of weeks or days and pay no attention to the current rates.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by Austen Heller » Sun Sep 15, 2013 2:47 am

fnord123 wrote: Current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.
I was considering holding some long-dated TIPS as part of the CASH component of the PP, when I came across this old thread.  The majority of the thread had been hijacked into an I-bond discussion, but I'm wondering: did the OP or anyone else ever enact this strategy?

Today (Sept 2013), I-bonds still have a 0% fixed rate, and 30-year TIPS are now yielding around 1.5% Real.  Seems like long TIPS deserve serious consideration.  Of course, you would be best served to hold the individual TIPS to maturity, and do so in a tax-advantaged account such as a Roth IRA, but as long as you can meet these criteria, the long TIPS seem like the way to go.  If anyone is considering this, and would like to buy as cheaply as possible (no commissions or bid/ask spreads), the next Treasury auction takes place in the middle of October.

William Bernstein discusses the benefits of long-dated TIPS in his pamphlet "Ages of the Investor" - highly recommended!  TIPS are specifically recommended as a component of a LMP - Liability Matching Portfolio, a way to make sure you are able to meet your obligations as retirement approaches.
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Re: TIPS held to maturity as "bottom" of cash component?

Post by fnord123 » Sun Sep 15, 2013 9:07 am

I never implemented this, mostly because I found additional ways to buy I-Bonds (in child's name + in a living trust).

When my current high yielding (sad when ~3% is high yielding) CDs run out in 2015, which currently are the bottom of my cash component and have a similar role as TIPS were proposed in this thread, I may roll them into TIPS if the 5Y CD rate is still sub-3%.

Did anyone else try this btw?  Still seems to me a good strategy if the TIPS are held in tax-advantaged space.
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