I don’t understand my TIPS

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strongboy2005
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I don’t understand my TIPS

Post by strongboy2005 »

I bought $100,000 of 30 year TIPS at auction this last February. They were 0% real. I was ok with that, anticipating $2,000 to $8,000 in interest payments each year. I had yet to receive any interest until yesterday…

With inflation running around 8%, and the bond paying semi-annually, I was expecting around a $4,000 interest payment. So imagine my confusion and sadness to see the interest payment be a paltry $62. What am I missing here? Did I really invest $100,000 in a highly volatile investment that paid me less than I would expect from a savings account? What happened here?
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Re: I don’t understand my TIPS

Post by nisiprius »

0% real means you don't get paid any coupon interest to speak of. Is the one that is actually 0.125%? That is the coupon rate and that's what you get paid. If I have my head screwed on right, it means you'd get paid 0.125%/2 = 0.0625% of the growing value of the principal, and the first interest payment ought to be something like $100,000 x 0.0625% = $62.50.

The inflation adjustment, which is where you are making almost all the money this bond is making, accumulates inside the bond, where it increases the amount of the bond principal. Only that tiny 0.0625% gets paid out in coupon payments.

You don't have any direct access to the principal until the bond matures in 30 years. In a general sort of way you might hope to access that principal by selling the bond on the market. The market ought to price in the growth of the principal. But with a maturity of 30 years, in the short term, market fluctuations and interest rate sensitivity might dwarf that growth of principal.

You will get your accumulated inflation adjustments when the bond matures. You will receive $100,000 plus thirty years of accumulated CPI adjustments. That will probably be much more than a bank account.

Since the coupon interest is based on the growing CPI-adjusted principal, those tiny coupon interest payments will grow with inflation.

Just to brace you, because you won't like this: although you don't have access to the growing principal, TIPS are an OID instrument (so are STRIPS), so at the end of the year you will be taxed on the growth of the principal. You will be paying the tax as you go, you don't get to defer it until the bond matures.

I agree that you have misunderstood TIPS. You might eyeball the market value of your TIPS and look for an opportunity to tell it at a profit. Otherwise, this would be an investment whose appropriate holding time would be a couple of decades.
Last edited by nisiprius on Thu Aug 18, 2022 9:02 pm, edited 4 times in total.
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squirrel1963
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Re: I don’t understand my TIPS

Post by squirrel1963 »

I am not a TIPS expert like Kevin M or #cruncher, but I can try to answer, what is the CUSIP and the ask price you were given at auction? There is no 0% 2052 TIP, all I see is 2052 0.125% TIP

EDIT: interest payment for each 1 bond will be ($1000 * 0.125%) * inflation_factor = $1.25 * inflation_factor, so it will be very little.
As others have pointed out the nominal gain in this case will be in the principal portion:

num_bonds * $1000 * inflation_factor for this TIP,

but you won't get it until maturity.

EDIT: as nisprius mentioned, you will not see the inflated principal until maturity (or sell, but you may lose on account of interest rate risk), but if held in taxable it is considered "phantom income" , a colorful description which means you have unrealized income which the IRS will tax you now.
Last edited by squirrel1963 on Thu Aug 18, 2022 8:52 pm, edited 3 times in total.
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Re: I don’t understand my TIPS

Post by mamster »

To add to what nisiprius said, the minimum coupon on a TIPS bond is 0.125%, which is what you're receiving. The coupon payment will increase along with inflation but it will be 0.125% (paid semiannually) in 2022 dollars for the life of the bond.
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strongboy2005
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Re: I don’t understand my TIPS

Post by strongboy2005 »

Thanks for the replies so far. So how do I figure out what my bonds are accumulating as time goes on?

912810TE8, quantity 103,000

Edit: also, I was mistaken, I got $68, not $62.

So 0.125% of 103,000 is $128.75. Half of that is $64.38. So it doesn’t exactly match up with the $68 I got, but at least I understand the concept now.
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Re: I don’t understand my TIPS

Post by nisiprius »

Look at the web page for Fiscal Service Mailing Lists and sign up for "CPI Press Releases for TIPS Current index ratios used for valuation of Inflation-Protected Securities." I think that's what you want. The latest one is here. But I am having a little trouble interpreting the index ratio and just how it is used.
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Re: I don’t understand my TIPS

Post by squirrel1963 »

strongboy2005 wrote: Thu Aug 18, 2022 9:02 pm Thanks for the replies so far. So how do I figure out what my bonds are accumulating as time goes on?

912810TE8, quantity 103,000
Right, so, let me take a look, here is treasury info from #cruncher : http://eyebonds.info/tips/2022/tips87_2022.html

You bought at auction so in theory the inflation index you bought at issue date on february 28 should be 1.00142. Today inflation index is 1.05792 so today your :

$103,000 real dollars are : $103,000 * (1.05792 / 1.00142) = $108,811.24 nominal dollars.

This assumes you paid at par, not sure what price you actually paid though.

EDIT: do double check in "Trading Treasuries" thread that this matches what Kevin M and #cruncher say. They are SME in this case.
Last edited by squirrel1963 on Thu Aug 18, 2022 9:22 pm, edited 1 time in total.
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Re: I don’t understand my TIPS

Post by squirrel1963 »

nisiprius wrote: Thu Aug 18, 2022 9:13 pm Look at the web page for Fiscal Service Mailing Lists and sign up for "CPI Press Releases for TIPS Current index ratios used for valuation of Inflation-Protected Securities." I think that's what you want. The latest one is here. But I am having a little trouble interpreting the index ratio and just how it is used.
Index ratio for today would be (cpi_today_date / cpi_issue_date). This is actually the most straightforward way to compute inflation factor in OP case. Or given he bought at auction he can just look at WSJ quote of adjusted principal:

https://www.wsj.com/market-data/bonds/tips

2052 Feb 15 0.125 80.26 80.31 +56 0.856 1058

so we have $105.8 adjusted principal based on par value.

please note:

(1) WSJ quotes $1058 based on $1000 par value
(2) WSJ quotes ask/bid price with fractions of 32s, so 80.26 bid means actually 80.(26/32) in decimal :oops:
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strongboy2005
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Re: I don’t understand my TIPS

Post by strongboy2005 »

It’s a good thing I bought this investment in an IRA. I would have been cash flow negative after taxes in a taxable account. I think I understand how they work now. Their “value” in the eyes of the government is $108,811, even though I could only sell them for a current market value of $87,955. It would be super fun to pay taxes on a $5,000 “gain” that is paying $136 per year in interest and has had a massive market decline.

I guess all I can say is “buyer beware”.

That being said, I have mine in an IRA, and I think I’ll just sit on it for now and do nothing…
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Re: I don’t understand my TIPS

Post by squirrel1963 »

strongboy2005 wrote: Thu Aug 18, 2022 9:22 pm It’s a good thing I bought this investment in an IRA. I would have been cash flow negative after taxes in a taxable account. I think I understand how they work now. Their “value” in the eyes of the government is $108,811, even though I could only sell them for a current market value of $87,955. It would be super fun to pay taxes on a $5,000 “gain” that is paying $136 per year in interest and has had a massive market decline.

I guess all I can say is “buyer beware”.

That being said, I have mine in an IRA, and I think I’ll just sit on it for now and do nothing…
Yes sir that is exactly how it is. The same happens for TIPS funds, phantom income is paid out as dividends, so it's somewhat opaque.
I built my 30 year TIPS ladder in IRA, but I'm not sure I could have afforded paying so many inflation adjustments in taxable, that's real serious cash flow, perhaps okay if you are still working, not okay for me as I just retired.
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Re: I don’t understand my TIPS

Post by squirrel1963 »

squirrel1963 wrote: Thu Aug 18, 2022 9:26 pm
strongboy2005 wrote: Thu Aug 18, 2022 9:22 pm It’s a good thing I bought this investment in an IRA. I would have been cash flow negative after taxes in a taxable account. I think I understand how they work now. Their “value” in the eyes of the government is $108,811, even though I could only sell them for a current market value of $87,955. It would be super fun to pay taxes on a $5,000 “gain” that is paying $136 per year in interest and has had a massive market decline.

I guess all I can say is “buyer beware”.

That being said, I have mine in an IRA, and I think I’ll just sit on it for now and do nothing…
Yes sir that is exactly how it is. The same happens for TIPS funds, phantom income is paid out as dividends, so it's somewhat opaque.
I built my 30 year TIPS ladder in IRA, but I'm not sure I could have afforded paying so many inflation adjustments in taxable, that's real serious cash flow, perhaps okay if you are still working, not okay for me as I just retired.
The one exception I made is with some excess cash I had last week in taxable, and decided to park it on the January 2023 TIP, because in this case I get everything back in January so I only see realized income not phantom income.
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Re: I don’t understand my TIPS

Post by FactualFran »

strongboy2005 wrote: Thu Aug 18, 2022 9:02 pm Thanks for the replies so far. So how do I figure out what my bonds are accumulating as time goes on?

912810TE8, quantity 103,000

Edit: also, I was mistaken, I got $68, not $62.

So 0.125% of 103,000 is $128.75. Half of that is $64.38. So it doesn’t exactly match up with the $68 I got, but at least I understand the concept now.
The $64.38 does not include the inflation adjustment made to the principal as of the interest payment date. The $68 is the interest payment including the inflation adjustment to the principal (the interest payment including cents is likely 68.01).
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Re: I don’t understand my TIPS

Post by invest4 »

strongboy2005 wrote: Thu Aug 18, 2022 9:22 pm That being said, I have mine in an IRA, and I think I’ll just sit on it for now and do nothing…
The bigger question in my mind is what are you are trying to accomplish with your investment in TIPS? My initial impression was that you may have been interested to create a substantial / steady income stream beginning now? Given the information that has been provided to you, am curious if you instead now consider a TIPS ladder or something different altogether? Of course, I recognize you may spend some time giving it a think.

More generally, appreciate everyone's questions /contributions on these fixed income topics as I try to figure out what to do for myself (age 50) over the longer term re: what and how for eventual retirement (current aspiration age 60).
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Re: I don’t understand my TIPS

Post by nisiprius »

squirrel1963 wrote: Thu Aug 18, 2022 9:19 pm
nisiprius wrote: Thu Aug 18, 2022 9:13 pm...The latest one is here. But I am having a little trouble interpreting the index ratio and just how it is used.
Index ratio for today would be (cpi_today_date / cpi_issue_date).
But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.

What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?

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Re: I don’t understand my TIPS

Post by Valuethinker »

strongboy2005 wrote: Thu Aug 18, 2022 9:22 pm It’s a good thing I bought this investment in an IRA. I would have been cash flow negative after taxes in a taxable account. I think I understand how they work now. Their “value” in the eyes of the government is $108,811, even though I could only sell them for a current market value of $87,955. It would be super fun to pay taxes on a $5,000 “gain” that is paying $136 per year in interest and has had a massive market decline.

I guess all I can say is “buyer beware”.

That being said, I have mine in an IRA, and I think I’ll just sit on it for now and do nothing…
TIPS have fallen with rising real interest rates. Just like all bonds in the last 12 months.

However at maturity, you get what you paid back + all accumulated inflation (there's a 3 month lag in inflation reporting, and a way of calculating that).

In effect, your "income" from this bond is coming as a higher coupon, but also as a higher principal ("inflation accretion"). It's as if some of your coupon were automatically reinvested in the bond. If you sold off some of the bond you could synthesise a higher income from the bond.

The price volatility in the bond is a pain-- you could have waited and bought at a cheaper price - but you know you will get your money (in real terms) back at maturity.
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Re: I don’t understand my TIPS

Post by Valuethinker »

nisiprius wrote: Fri Aug 19, 2022 5:50 am
squirrel1963 wrote: Thu Aug 18, 2022 9:19 pm
nisiprius wrote: Thu Aug 18, 2022 9:13 pm...The latest one is here. But I am having a little trouble interpreting the index ratio and just how it is used.
Index ratio for today would be (cpi_today_date / cpi_issue_date).
But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.
Is that not the accrued interest?
What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?

Image
I think they interpolate a daily CPI. Also remember the CPI used is reported with a 3 month lag, so they have to adjust for that.
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Re: I don’t understand my TIPS

Post by dbr »

The TIPS fund VAIPX paid a dividend on 7/1/22 of $0.6213/share. On a price of $25.08 that is an annualized rate of 9.90%.

TIPS funds do pay out the inflation increment in the dividend. That payment is taxable whether it is paid by a fund or retained as in an individual TIPS.

If you don't retain (reinvest) that increment your holding will not pace inflation, so buying TIPS to pace inflation and then spending the dividend is shooting yourself in the foot.

Seriously, for the long term investor saving money for 30 years of working and spending those savings through 30 years of retirement just holding bonds in low cost mutual funds works just fine. In a long term portfolio of stocks and bonds volatility, meaning year to year variation in return, is inevitable no matter what you do and is best left as something to live with. It comes with the territory.
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Re: I don’t understand my TIPS

Post by Svensk Anga »

nisiprius wrote: Fri Aug 19, 2022 5:50 am But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.

What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?
The index ratio declines in September because there was a tiny bit of deflation in non-seasonally adjusted CPI in July. At end June the CPI-U was 296.311. At end July it had declined to 296.276 or by -0.012%. The TIPS value adjusts daily in proportion to that rate of decline, so by -0.012%/30.

Ref CPI is the interpolation day-by-day of the monthly movement. They aren't predicting CPI, they are boosting (or cutting) TIPS values through September according to what happened to CPI during July. They use July CPI for September because coming out mid-August it is the latest available.
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Re: I don’t understand my TIPS

Post by Valuethinker »

Svensk Anga wrote: Fri Aug 19, 2022 8:36 am
nisiprius wrote: Fri Aug 19, 2022 5:50 am But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.

What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?
The index ratio declines in September because there was a tiny bit of deflation in non-seasonally adjusted CPI in July. At end June the CPI-U was 296.311. At end July it had declined to 296.276 or by -0.012%. The TIPS value adjusts daily in proportion to that rate of decline, so by -0.012%/30.

Ref CPI is the interpolation day-by-day of the monthly movement. They aren't predicting CPI, they are boosting (or cutting) TIPS values through September according to what happened to CPI during July. They use July CPI for September because coming out mid-August it is the latest available.
Thank you - that clears up a confusion I had. Much appreciated.
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Re: I don’t understand my TIPS

Post by squirrel1963 »

Valuethinker wrote: Fri Aug 19, 2022 6:11 am
nisiprius wrote: Fri Aug 19, 2022 5:50 am
squirrel1963 wrote: Thu Aug 18, 2022 9:19 pm
nisiprius wrote: Thu Aug 18, 2022 9:13 pm...The latest one is here. But I am having a little trouble interpreting the index ratio and just how it is used.
Index ratio for today would be (cpi_today_date / cpi_issue_date).
But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.
Is that not the accrued interest?
What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?

Image
I think they interpolate a daily CPI. Also remember the CPI used is reported with a 3 month lag, so they have to adjust for that.
Yup, correct. The Treasury doesn't know future inflation of course, so the CPI used for September is the CPI reported for June (3 months lag). CPI numbers are reported on a monthly basis, so daily values for September are a linear interpolation between September CPI and October CPI.

The numbers must have gone down sligthly because Presumably we had a very slight deflation in June.
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Re: I don’t understand my TIPS

Post by squirrel1963 »

Svensk Anga wrote: Fri Aug 19, 2022 8:36 am
nisiprius wrote: Fri Aug 19, 2022 5:50 am But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.

What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?
The index ratio declines in September because there was a tiny bit of deflation in non-seasonally adjusted CPI in July. At end June the CPI-U was 296.311. At end July it had declined to 296.276 or by -0.012%. The TIPS value adjusts daily in proportion to that rate of decline, so by -0.012%/30.

Ref CPI is the interpolation day-by-day of the monthly movement. They aren't predicting CPI, they are boosting (or cutting) TIPS values through September according to what happened to CPI during July. They use July CPI for September because coming out mid-August it is the latest available.
Oh that's interesting, I thought there was a constant 3-month lag in the CPI used for TIPS.
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Re: I don’t understand my TIPS

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deleted. duplicate comment.
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Re: I don’t understand my TIPS

Post by Svensk Anga »

squirrel1963 wrote: Fri Aug 19, 2022 4:59 pm
Svensk Anga wrote: Fri Aug 19, 2022 8:36 am
nisiprius wrote: Fri Aug 19, 2022 5:50 am But why does the Treasury's tabulated "index ratio" decline microscopically day by day? This seems to be saying that if the principal value of the bond were $1,064.43 on September 1st, by September 15th it would be down to only $1,064.37.

What is "ref CPI?" Is CPI calculated day by day, I thought it was only monthly. And how do they know what it will be two weeks into the future?
The index ratio declines in September because there was a tiny bit of deflation in non-seasonally adjusted CPI in July. At end June the CPI-U was 296.311. At end July it had declined to 296.276 or by -0.012%. The TIPS value adjusts daily in proportion to that rate of decline, so by -0.012%/30.
3
Ref CPI is the interpolation day-by-day of the monthly movement. They aren't predicting CPI, they are boosting (or cutting) TIPS values through September according to what happened to CPI during July. They use July CPI for September because coming out mid-August it is the latest available.
Oh that's interesting, I thought there was a constant 3-month lag in the CPI used for TIPS.
3 months is almost right. Inflation occurring on July 1 is not fully incorporated into TIPS values until October 1. Most of it is there in September though.
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