Fixed income portfolio review for newish retiree who doesn't understand TIPs

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DebiT
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Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

I've been reading McQ's latest post on long term TIPS, and would love some feedback on FI portion of my 40/60 portfolio. I'm an age 65 newish retiree, with survivor SS to be followed by my own higher SS at 70. Portfolio today is about $1.6M, current residual expense withdrawal is about $60K, reducing to about $44K in 5 years. I use age 100 as my lifespan.

About 68% of my portfolio is in IRAs, $73K going to Roth each year, taxable account slated to be spent down at some point.

I have been working hard to understand bond funds and T Bills for my "cash/cash", of which I have a 2 years of expenses reserve. Now along comes the TIPS topic, which I fear may be important, time-sensitive, and yet has me utterly confused.

Should I ignore TIPS, change out all/most of FI for TIPS, buy a certain amount, or ????. It's a partly facetious question, but not really.

Here's the portfolio:

Stock funds (40%)
VTI 20%
XLU 4% (Spider Utilities Select Sector) a holdover, but I like the dividends
RWO 4%
VXUS 12%

Fixed Income and Cash (60%)
50K TBill (2nd year cash)
33K MM (Current year cash and a little extra)
Therefore
Cash 5%
BND 43%
PONAX 10%
FAX 2%

I don't know what other information to give to help anyone explain if buying a long TIP, or several, is a good idea in my case and in today's environment. Am prepared to learn, if my poor brain can take it in.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
Dude2
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Dude2 »

If you buy TIPS you remove one risk out of a basket of bond risks, e.g. unexpected inflation risk. The person that holds a large percentage of bonds is far more exposed to this risk. If this risk show up, the money disappears, never to return. Interest rate risk is another, but, when the bond fund is held for its duration, it will generally recover. This is far different from money that disappears, never to return. Unlike stocks that have large upside potential, this is not the case for bonds. If bonds are for safety, then some people have decided that removing this one risk is important enough to take action, i.e. buy TIPS. I like the Fidelity fund FIPDX -- an index fund that holds a variety of TIPS durations, averaging to intermediate. That's a simple and lazy approach, like buying BND.

I don't want to go down the rabbit hole of a Liability Matching Portfolio, but just want to say that if TIPS are less risky than other bonds, it stands to reason that they will offer less reward. Therefore, if you are a BND holder, you are exposing yourself to other risk factors, and the idea is that you should be compensated for that. If unexpected inflation doesn't show up, then people who hold BND should get higher returns than people that hold FIPDX. I say all this because at some point people will evaluate looking backwards whether they should have been in one or the other and think themselves stupid for changing their plan; however, the point is that if you were in FIPDX vs BND you weren't exposed to unexpected inflation risk.

Note, there is an alternative consideration to all of this portfolio management for people who don't want to deal with it which is to buy annuities. If you are focused on amount of money per year to live on, then there is that path to consider, if it makes sense and you trust it versus yourself.
Then ’tis like the breath of an unfee’d lawyer.
Escapevelocity
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Escapevelocity »

Dude2 wrote: Fri Sep 30, 2022 4:49 am If you buy TIPS you remove one risk out of a basket of bond risks, e.g. unexpected inflation risk. The person that holds a large percentage of bonds is far more exposed to this risk. If this risk show up, the money disappears, never to return. Interest rate risk is another, but, when the bond fund is held for its duration, it will generally recover. This is far different from money that disappears, never to return. Unlike stocks that have large upside potential, this is not the case for bonds. If bonds are for safety, then some people have decided that removing this one risk is important enough to take action, i.e. buy TIPS. I like the Fidelity fund FIPDX -- an index fund that holds a variety of TIPS durations, averaging to intermediate. That's a simple and lazy approach, like buying BND.

I don't want to go down the rabbit hole of a Liability Matching Portfolio, but just want to say that if TIPS are less risky than other bonds, it stands to reason that they will offer less reward. Therefore, if you are a BND holder, you are exposing yourself to other risk factors, and the idea is that you should be compensated for that. If unexpected inflation doesn't show up, then people who hold BND should get higher returns than people that hold FIPDX. I say all this because at some point people will evaluate looking backwards whether they should have been in one or the other and think themselves stupid for changing their plan; however, the point is that if you were in FIPDX vs BND you weren't exposed to unexpected inflation risk.

Note, there is an alternative consideration to all of this portfolio management for people who don't want to deal with it which is to buy annuities. If you are focused on amount of money per year to live on, then there is that path to consider, if it makes sense and you trust it versus yourself.
How is buying annuities address the risk of unexpected inflation?
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

Escapevelocity wrote: Fri Sep 30, 2022 5:31 am
Dude2 wrote: Fri Sep 30, 2022 4:49 am If you buy TIPS you remove one risk out of a basket of bond risks, e.g. unexpected inflation risk. The person that holds a large percentage of bonds is far more exposed to this risk. If this risk show up, the money disappears, never to return. Interest rate risk is another, but, when the bond fund is held for its duration, it will generally recover. This is far different from money that disappears, never to return. Unlike stocks that have large upside potential, this is not the case for bonds. If bonds are for safety, then some people have decided that removing this one risk is important enough to take action, i.e. buy TIPS. I like the Fidelity fund FIPDX -- an index fund that holds a variety of TIPS durations, averaging to intermediate. That's a simple and lazy approach, like buying BND.

I don't want to go down the rabbit hole of a Liability Matching Portfolio, but just want to say that if TIPS are less risky than other bonds, it stands to reason that they will offer less reward. Therefore, if you are a BND holder, you are exposing yourself to other risk factors, and the idea is that you should be compensated for that. If unexpected inflation doesn't show up, then people who hold BND should get higher returns than people that hold FIPDX. I say all this because at some point people will evaluate looking backwards whether they should have been in one or the other and think themselves stupid for changing their plan; however, the point is that if you were in FIPDX vs BND you weren't exposed to unexpected inflation risk.

Note, there is an alternative consideration to all of this portfolio management for people who don't want to deal with it which is to buy annuities. If you are focused on amount of money per year to live on, then there is that path to consider, if it makes sense and you trust it versus yourself.
How is buying annuities address the risk of unexpected inflation?
A fixed annuity does not address any inflation unless 1) you get one with a COLA that partly offsets inflation or even completely offsets inflation some of the time or maybe 2) is enough more income than you need that you can save some for spending later, or 3) the SPIA is actually building up your Social Security by delayed claiming and it is inflation indexed. It is still true that having a fixed life income stream might be helpful to somewhat isolating people from the impact of volatile investments. A lot also depends on when an SPIA is bought as the payout depends on interest rates at the time, which is also true of the cost of a TIPS ladder.

What is not clear at all is the degree to which mixtures of stocks, bonds, annuities, and SS are better off with more money or less money in the one or the other. There tend to be offsetting benefits under various conditions.
Topic Author
DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

Dude2 wrote: Fri Sep 30, 2022 4:49 am If you buy TIPS you remove one risk out of a basket of bond risks, e.g. unexpected inflation risk. The person that holds a large percentage of bonds is far more exposed to this risk. If this risk show up, the money disappears, never to return. Interest rate risk is another, but, when the bond fund is held for its duration, it will generally recover. This is far different from money that disappears, never to return. Unlike stocks that have large upside potential, this is not the case for bonds. If bonds are for safety, then some people have decided that removing this one risk is important enough to take action, i.e. buy TIPS. I like the Fidelity fund FIPDX -- an index fund that holds a variety of TIPS durations, averaging to intermediate. That's a simple and lazy approach, like buying BND.

I don't want to go down the rabbit hole of a Liability Matching Portfolio, but just want to say that if TIPS are less risky than other bonds, it stands to reason that they will offer less reward. Therefore, if you are a BND holder, you are exposing yourself to other risk factors, and the idea is that you should be compensated for that. If unexpected inflation doesn't show up, then people who hold BND should get higher returns than people that hold FIPDX. I say all this because at some point people will evaluate looking backwards whether they should have been in one or the other and think themselves stupid for changing their plan; however, the point is that if you were in FIPDX vs BND you weren't exposed to unexpected inflation risk.

Note, there is an alternative consideration to all of this portfolio management for people who don't want to deal with it which is to buy annuities. If you are focused on amount of money per year to live on, then there is that path to consider, if it makes sense and you trust it versus yourself.
Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
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jeffyscott
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by jeffyscott »

You could consider TIPS to fill the gap between SS and your total spending, if there is a gap.

I have a pension that doesn't have a guaranteed COLA. So it may or may not keep up with inflation. When we start SS, we expect to have more than enough from that and the pension. So, while I don't do a full liability matching portfolio, I include TIPS and I-bonds as inflation is potential risk to the pension's value.
Robot Monster
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Robot Monster »

DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

Please do not forget that TIPS are indexed to actual inflation expected or not. The conversation about unexpected inflation applies to people who want to try to figure out if nominals are going to "beat" TIPS or vice versa. Trying to figure out which asset is going to "beat" which other asset is probably not a productive way to invest. If inflation is likely to be a hazard to your plans you can avoid inflation as far as the assets you have in fixed income by investing in TIPS. In practice the cost of that is very low.
Topic Author
DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

Robot Monster wrote: Fri Sep 30, 2022 9:28 am
DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
What does the term 10 year breakeven mean? This is part of what I’m trying to learn. Likely I won’t change anything, but I’m curious
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
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HueyLD
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by HueyLD »

DebiT,

Have you considered getting the finance buff’s book on TIPS?

https://thefinancebuff.com/explore-tips

It provides you with a good understanding of TIPS.
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DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

HueyLD wrote: Fri Sep 30, 2022 9:45 am DebiT,

Have you considered getting the finance buff’s book on TIPS?

https://thefinancebuff.com/explore-tips

It provides you with a good understanding of TIPS.
Thanks, I may look into that.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
CletusCaddy
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by CletusCaddy »

dbr wrote: Fri Sep 30, 2022 9:35 am Please do not forget that TIPS are indexed to actual inflation expected or not. The conversation about unexpected inflation applies to people who want to try to figure out if nominals are going to "beat" TIPS or vice versa. Trying to figure out which asset is going to "beat" which other asset is probably not a productive way to invest. If inflation is likely to be a hazard to your plans you can avoid inflation as far as the assets you have in fixed income by investing in TIPS. In practice the cost of that is very low.
I agree that the “unexpected inflation” terminology is unhelpful for novices trying to understand TIPS. It confused me as well, and made me mistakenly believe that TIPS only paid out anything if inflation turned out higher than expectations. Not so, TIPS will pay out the inflation rate whatever it is.
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

CletusCaddy wrote: Fri Sep 30, 2022 9:49 am
dbr wrote: Fri Sep 30, 2022 9:35 am Please do not forget that TIPS are indexed to actual inflation expected or not. The conversation about unexpected inflation applies to people who want to try to figure out if nominals are going to "beat" TIPS or vice versa. Trying to figure out which asset is going to "beat" which other asset is probably not a productive way to invest. If inflation is likely to be a hazard to your plans you can avoid inflation as far as the assets you have in fixed income by investing in TIPS. In practice the cost of that is very low.
I agree that the “unexpected inflation” terminology is unhelpful for novices trying to understand TIPS. It confused me as well, and made me mistakenly believe that TIPS only paid out anything if inflation turned out higher than expectations. Not so, TIPS will pay out the inflation rate whatever it is.
The same comment applies to the fact that if inflation falls, then the TIPS is indexed down. But, so what? That is what should happen if you want an investment that is set to real dollars. Note there is a floor under that which is one never gets back less than the face value.
Robot Monster
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Robot Monster »

DebiT wrote: Fri Sep 30, 2022 9:44 am
Robot Monster wrote: Fri Sep 30, 2022 9:28 am
DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
What does the term 10 year breakeven mean? This is part of what I’m trying to learn. Likely I won’t change anything, but I’m curious
The 10-year breakeven represents the expected inflation over the next ten years. It's calculated by taking the difference between the yield on the 10yr Treasury (which is currently 3.74%) and the real yield on the 10yr TIPS (1.61%).

3.74-1.61=2.13

(It was 2.19% yesterday, 2.13% at the moment.)

So, if inflation does average 2.13%, it won't make a difference if you buy a 10yr Treasury, or 10yr TIPS. They will both give you a 1.61% real yield.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by jebmke »

DebiT wrote: Fri Sep 30, 2022 9:44 am
Robot Monster wrote: Fri Sep 30, 2022 9:28 am
DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
What does the term 10 year breakeven mean? This is part of what I’m trying to learn. Likely I won’t change anything, but I’m curious
I think it means that if inflation is 2.19% then nominal bonds and Tips are more or less equivalent investments for the duration.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

jebmke wrote: Fri Sep 30, 2022 10:10 am
DebiT wrote: Fri Sep 30, 2022 9:44 am
Robot Monster wrote: Fri Sep 30, 2022 9:28 am
DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
What does the term 10 year breakeven mean? This is part of what I’m trying to learn. Likely I won’t change anything, but I’m curious
I think it means that if inflation is 2.19% then nominal bonds and Tips are more or less equivalent investments for the duration.
I think so. It means if you think you can predict inflation over the next ten years then you know which investment will be the winning choice. But since expected inflation is the only way to guess what inflation will do, it leaves a person without a way to decide. Alternatively it means the market as a whole is investing as if it knows what inflation is going to be over the next ten years, or investors who think one thing or are incentivized by one thing being balanced by investors at the opposite. Does the concept that a market can know something compute?
jebmke
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by jebmke »

dbr wrote: Fri Sep 30, 2022 10:17 am
jebmke wrote: Fri Sep 30, 2022 10:10 am
DebiT wrote: Fri Sep 30, 2022 9:44 am
Robot Monster wrote: Fri Sep 30, 2022 9:28 am
DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
What does the term 10 year breakeven mean? This is part of what I’m trying to learn. Likely I won’t change anything, but I’m curious
I think it means that if inflation is 2.19% then nominal bonds and Tips are more or less equivalent investments for the duration.

I think so. It means if you think you can predict inflation over the next ten years then you know which investment will be the winning choice. But since expected inflation is the only way to guess what inflation will do, it leaves a person without a way to decide. Alternatively it means the market as a whole is investing as if it knows what inflation is going to be over the next ten years, or investors who think one thing or are incentivized by one thing being balanced by investors at the opposite. Does the concept that a market can know something compute?
I guess I view it that while nobody really knows what inflation will be, if we have to pick an estimate, the collective wisdom of the bond market is the best we can come up with (knowing it is wrong).

The only time I took a Tips position was in 2008 and I really didn't think much about inflation. The real rate was 3%+ and, frankly, I "market timed" and went long with a large position. I was really focused on the real rate and decided that 3% real for zero default risk was pretty good.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

jebmke wrote: Fri Sep 30, 2022 10:32 am
dbr wrote: Fri Sep 30, 2022 10:17 am
jebmke wrote: Fri Sep 30, 2022 10:10 am
DebiT wrote: Fri Sep 30, 2022 9:44 am
Robot Monster wrote: Fri Sep 30, 2022 9:28 am

Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
What does the term 10 year breakeven mean? This is part of what I’m trying to learn. Likely I won’t change anything, but I’m curious
I think it means that if inflation is 2.19% then nominal bonds and Tips are more or less equivalent investments for the duration.

I think so. It means if you think you can predict inflation over the next ten years then you know which investment will be the winning choice. But since expected inflation is the only way to guess what inflation will do, it leaves a person without a way to decide. Alternatively it means the market as a whole is investing as if it knows what inflation is going to be over the next ten years, or investors who think one thing or are incentivized by one thing being balanced by investors at the opposite. Does the concept that a market can know something compute?
I guess I view it that while nobody really knows what inflation will be, if we have to pick an estimate, the collective wisdom of the bond market is the best we can come up with (knowing it is wrong).

The only time I took a Tips position was in 2008 and I really didn't think much about inflation. The real rate was 3%+ and, frankly, I "market timed" and went long with a large position. I was really focused on the real rate and decided that 3% real for zero default risk was pretty good.
At this point I own only TIPS funds in fixed income and probably should have just done that a long way back. That is because my own situation is one where inflation at whatever it is would be a concern and it makes sense to not have that variable in some fraction of the investments. I don't have in in SS and in fixed income. I do have it in the pension and in equities.

Probably the key statement in what you say is "If we have to pick an estimate." I would like to not have to pick an estimate but it is relevant because two of my assets/income streams have inflation related performance. I do hope something around 2%-3% is valid for the next some years and not 7%.
rich126
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by rich126 »

Robot Monster wrote: Fri Sep 30, 2022 9:28 am
DebiT wrote: Fri Sep 30, 2022 9:01 am Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
Inflation is here, but is expected to get under control. The 10-year breakeven is only 2.19%, after all. It's not like inflation expectations are crazy high, and maybe not the best time to buy.
I'm not necessarily an annuity person and I'm not sure if I will ever get one but here is where my thoughts would be on that topic.

1. Based on the post I'm replying to the person is saying the inflation expectations is 2.19%. That seems low but let's roll with it.
2. Currently inflation is high, compared to recent years. 8% or whatever it currently is at.
3. Annuity payout (probably wrong term but I'm referring to yearly payout divided by amount "invested") is around 6% (not actual return on investment!). I think when I ran these numbers at immediateannuities.com for a married couple, 60 yrs old, a year or so ago, the number was closer to 4%.

So if you were going to get an annuity, and you expect inflation to come under control soon and not continue to be high or go higher, this seems like a good time for someone older to get an annuity if they ever would get an annuity. I'm saying that based on the fact that if inflation does come back to 3% or lower, the payout of an annuity is going to be lower (well, excluding if you wait and you get older and you get more mortality credits or whatever the term is used).

Sure there is a ton to not like about annuities but people with them certainly aren't worrying about the stock market, of course now they are worrying about inflation.
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miket29
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by miket29 »

I don't think there is a "right" decision, there are tradeoffs between choices and you need to decide which risk(s) you want to accept and avoid. My understanding is you are taking $60K/yr out of your IRA for annual expenses and that it is coming from selling BND. Social Security starts in 5 years and your expenses drop then.

BND has a duration of 6.7 years. While the true meaning of duration is technical and I don't claim to understand it, duration can be used as a rule of thumb to predict how much a fund will drop with a rise in interest rates and how many years it will take to recover the drop thru higher interest. If rates rise 1% then BND will drop 6.7% but it will be earning 1% higher interest so it will take 6.7 years to recover the loss. The inverse holds if rates drop. BND holds a variety of maturities and the entire interest rate curve doesn't shift by the exact same amount at every maturity so this is a heuristic rather than a mathematical equation.

If you buy TIPS bonds on the secondary market and hold them to maturity then you get close to the yield promised on the day you purchased them no matter what inflation does and the money you spent to purchase the bonds is returned increased by the inflation amount to maturity. I say "close to" because there's the question of the rate you get reinvesting the dividends but with the low coupon rates TIPS have this isn't a big issue. TIPS are returning 1.7% to 2% or so over the next 5 years depending on the maturity chosen (see https://www.wsj.com/market-data/bonds/t ... _tips_full)

So to present two choices (and these are far from the only choices)
  • hold BND as you do currently and sell 60K each year for 5 years at the then current price
  • buy TIPS of maturities from 1-5 years and use the money when they mature for expenses
I don't know what interest rates will do, nor perhaps does anyone. Bill Gross ran a hedge fund and was the bond king until he made a few bad calls and then he wasn't. Sentiment these days seems to be for rates to rise further, but sentiment could be wrong.

Rates in nominal bonds come from investor demand for real return plus compensation for expected inflation. If rates rise and you sell before 6.7 years then you've lost value. Furthermore the expected inflation rate part of longer bonds is the expected inflation over longer periods so, even ignoring the drop from interest rates rising, BND has not returned enough in dividends this past year to keep up with inflation. The SEC yield is currently about 4% so that's the best predictor of BND dividends going forward. If interest rates drop BND will return even more.

TIPS held to maturity compensate you pretty closely for the actual inflation/deflation you experienced from the date of purchase. Although you can only buy TIPS in multiples of $1K face value, hypothetically if you could buy $58,600 of TIPS today that mature in Jan 2024 (yielding 2.355%) then the dividends plus maturity payout would return a total of $60K with that $60K increased by inflation between now and Jan 2024.

So between these alternatives TIPS offer certainty of return in inflation-adjusted dollars but an interest rate lower than the current 4% BND is paying. The return on BND you actually gets depends on what real interest rates and expected inflation due between now and sale.
Last edited by miket29 on Fri Sep 30, 2022 8:44 pm, edited 9 times in total.
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

miket29 wrote: Fri Sep 30, 2022 1:44 pm I don't think there is a "right" decision, there are tradeoffs between choices and you need to decide which risk(s) you want to accept and avoid. My understanding is you are taking $60K/yr out of your IRA for annual expenses and that it is coming from selling BND. Social Security starts if 5 years and your expenses drop then.

BND has a duration of 6.7 years. While the true meaning of duration is technical and I don't claim to understand it, duration can be used as a rule of thumb to predict how much a fund will drop with a rise in interest rates and how many years it will take to recover the drop thru higher interest. If rates rise 1% then BND will drop 6.7% but it will be earning 1% higher interest so it will take 6.7 years to recover the loss. The inverse holds if rates drop. BND holds a variety of maturities and the entire interest rate curve doesn't shift by the exact same amount at every maturity so this is a heuristic rather than a mathematical equation.

If you buy TIPS bonds on the secondary market and hold them to maturity then you get close to the yield promised on the day you purchased them no matter what inflation does. I say "close to" because there's the question of the rate you get reinvesting the dividends but with the low coupon rates TIPS have this isn't a big issue. TIPS are returning 1.7% to 2% or so over the next 5 years depending on the maturity chosen (see https://www.wsj.com/market-data/bonds/t ... _tips_full)

So to present two choices (and these are by far the only choices)
  • hold BND as you do currently and sell 60K each year for 5 years at the then current price
  • buy TIPS of maturities from 1-5 years and use the money when they mature for expenses
I don't know what interest rates will do, nor perhaps does anyone. Bill Gross ran a hedge fund and was the bond king until he made a few bad calls and then wasn't. Sentiment these days seems to be for rates to rise further, but sentiment could be wrong.

Rates in nominal bonds come from investor demand for real return plus compensation for expected inflation. If rates rise and you sell before 6.7 years then you've lost value. Furthermore the expected inflation rate part of longer bonds is the expected inflation over longer periods so even without the change in rates BND has not returned enough in dividends this past year to keep up with inflation. The SEC yield is currently about 4% so that's the best predictor of BND dividends going forward. If interest rates drop BND will return even more.

TIPS held to maturity compensate you pretty closely for the actual inflation you experienced from the date of purchase.

So between these two TIPS offer certainty of return in inflation-adjusted dollars but an interest rate lower than the current 4% BND is paying. The return on BND you actually gets depends on what real interest rates and expected inflation due between now and sale.
These are good comments. I wouldn't get into duration theory, but what I would say is that if you have only $300,000 and want $60k a year for five years a bond fund would be a bad idea and either a cash savings account or a set of bonds maturing each year would be a good choice. TIPS are actually a less good choice because with inflation you might get back more than you need, so you are off on meeting your exact need. TIPS could also be at a negative real rate and again you would be off. If you want $60k inflation indexed, then do use TIPS.

On the other hand if you have $2M and $500K of that is in BND, then taking the $60k a year for five years plus whatever else you need and then moving on, then there is no point in engaging in useless financial engineering.

If you have $1M and you are going through an extra $300k of it in the first five years then you are probably at a point of whatever. Some people would be comfortable to put that money in savings or a ladder and others would just spend as needed and move on. It is possible to try and model the outcomes in FireCalc or something and see if you can find a diffference. In FireCalc what you do is start with a $300k smaller portfolio but add a $60k income stream that starts now and then a -$60k income stream that starts five years from now. FireCalc does not have a way to enter an income stream that starts at a date and ends at another date. All of this coordinates when you enter for the start of SS, etc.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

An additional point is that I would have to sell BND in order to buy TIPS. I should also point out that for the next 5 years I need $60K, but after that I still need $44K yearly forever. This may be lessened by any growth, interest or dividends, but it still is what it is.

I think what I'm understanding for now is that if I had cash and the choice of buying at least some TIPS instead of BND, that might be wise.

But if I need to sell BND to buy TIPS, does that make sense, given the scenario I describe?. In my portfolio, it works out that today I have about 15 years in fixed income, which as I said in my OP is mostly BND, some PONAX
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by squirrel1963 »

dbr wrote: Fri Sep 30, 2022 8:33 am
Escapevelocity wrote: Fri Sep 30, 2022 5:31 am
Dude2 wrote: Fri Sep 30, 2022 4:49 am If you buy TIPS you remove one risk out of a basket of bond risks, e.g. unexpected inflation risk. The person that holds a large percentage of bonds is far more exposed to this risk. If this risk show up, the money disappears, never to return. Interest rate risk is another, but, when the bond fund is held for its duration, it will generally recover. This is far different from money that disappears, never to return. Unlike stocks that have large upside potential, this is not the case for bonds. If bonds are for safety, then some people have decided that removing this one risk is important enough to take action, i.e. buy TIPS. I like the Fidelity fund FIPDX -- an index fund that holds a variety of TIPS durations, averaging to intermediate. That's a simple and lazy approach, like buying BND.

I don't want to go down the rabbit hole of a Liability Matching Portfolio, but just want to say that if TIPS are less risky than other bonds, it stands to reason that they will offer less reward. Therefore, if you are a BND holder, you are exposing yourself to other risk factors, and the idea is that you should be compensated for that. If unexpected inflation doesn't show up, then people who hold BND should get higher returns than people that hold FIPDX. I say all this because at some point people will evaluate looking backwards whether they should have been in one or the other and think themselves stupid for changing their plan; however, the point is that if you were in FIPDX vs BND you weren't exposed to unexpected inflation risk.

Note, there is an alternative consideration to all of this portfolio management for people who don't want to deal with it which is to buy annuities. If you are focused on amount of money per year to live on, then there is that path to consider, if it makes sense and you trust it versus yourself.
How is buying annuities address the risk of unexpected inflation?
A fixed annuity does not address any inflation unless 1) you get one with a COLA that partly offsets inflation or even completely offsets inflation some of the time or maybe 2) is enough more income than you need that you can save some for spending later, or 3) the SPIA is actually building up your Social Security by delayed claiming and it is inflation indexed. It is still true that having a fixed life income stream might be helpful to somewhat isolating people from the impact of volatile investments. A lot also depends on when an SPIA is bought as the payout depends on interest rates at the time, which is also true of the cost of a TIPS ladder.

What is not clear at all is the degree to which mixtures of stocks, bonds, annuities, and SS are better off with more money or less money in the one or the other. There tend to be offsetting benefits under various conditions.
Yeah who knows, I don't think there is a perfect answer, and it also depends on your circumstances / needs, although I do think there is space for all the above in many cases. As for me, we have a TIPS ladder which along with I-Bonds and SSA benefits (when they come) covers 100% of our living expenses (or at least it's supposed to). The rest is equities, with some nominal treasuries as "cash reserve". I don't claim this is best approach, I just believe that it's suited for our needs. At some point leftover TIPS will need to be annuitized I believe to cover longevity risk, but we're a long way from that and probably our plans might change.
LMP | Liability Matching Portfolio | safe portfolio: TIPS ladder + I-bonds + Treasuries | risky portfolio: US stocks / US REIT / International stocks
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by miket29 »

DebiT wrote: Fri Sep 30, 2022 3:51 pm An additional point is that I would have to sell BND in order to buy TIPS. I should also point out that for the next 5 years I need $60K, but after that I still need $44K yearly forever. This may be lessened by any growth, interest or dividends, but it still is what it is.

I think what I'm understanding for now is that if I had cash and the choice of buying at least some TIPS instead of BND, that might be wise.
I'm assuming you have the BND in your IRA so there is no tax consequence. TIPS are better held in a tax-deferred account since in a regular account you owe tax on the adjustment the Treasury does to the principal to match it to inflation.

What you have in BND is what you have, meaning that even though you may have a loss from what you paid to purchase it you can only affect the future. Behavioral economists have found a lot of people have an aversion to selling at a loss so they hold on until they hopefully break even. Sometimes that works, sometimes the investment goes down further.

So from here going forward it comes down to what risks you prefer to take/avoid and how it plays into your overall strategy. I mentioned in an earlier reply some of the tradeoffs (under an assumption you want to fund the next 5 years expenses from bonds) between sticking with BND and putting together a 5-year TIPS ladder (or maybe just some of it since you have cash on hand).

There are many other choices. Some people build longer ladders, up to 20 years or more out. Some hold a shorter-term bond fund and a longer-term one. And from a higher-level view you need to decide what role(s) bonds play in your portfolio. Are they (or some of them) there to sell to fully fund future expenses? To sell only if stocks are in a down market but otherwise you'll sell stock gains first and take the rest from bonds? To reduce the volatility of your overall portfolio but you plan on selling both stocks and bonds? Some other reasons?
Last edited by miket29 on Fri Sep 30, 2022 8:30 pm, edited 1 time in total.
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DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

These are good questions, getting me to think about the various risks in a different way.

Yes, all my bonds are in tax-deferred. The plan I am following is from Michael McClung's Living Off Your Money. It means selling only bonds, not buying more stock so no rebalancing, and harvesting stock gains if they hit higher than 120% of their value when I retired (going from memory but I think that's it.) If you're not familiar with his book, it's very good, very anaylitcal, well researched.

So I guess for me it would be what I think about risks/rewards of TIPS vs BND, which I guess hinges on what I think about inflation risk vs interest rate risk. There is definitely a behavioral thing at work as I write this. I can "see" higher vs lower interest/returns, but at least so far I can't "see" inflation in my investments. I get that my $60k draw buys less if there is inflation, so I guess inflation means I'd need to draw more. I don't know how much my personal inflation is yet (no mortgage, paid for newish car, steady property tax). I'm not sure how to educate myself about that.

Lots to think about. Thank you
Last edited by DebiT on Sat Oct 01, 2022 9:22 am, edited 2 times in total.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
CloseEnough
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by CloseEnough »

dbr wrote: Fri Sep 30, 2022 1:58 pm

These are good comments.

On the other hand if you have $2M and $500K of that is in BND, then taking the $60k a year for five years plus whatever else you need and then moving on, then there is no point in engaging in useless financial engineering.

If you have $1M and you are going through an extra $300k of it in the first five years then you are probably at a point of whatever.
I agree Miket29 explanation is helpful to understanding the question. I don't understand the above comments on "useless financial engineering" and "point of whatever"? Are you saying that with those numbers there is "enough", so the likely small differences in choices for fixed income withdrawals over 5 years don't matter?
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

CloseEnough wrote: Sat Oct 01, 2022 8:56 am
dbr wrote: Fri Sep 30, 2022 1:58 pm

These are good comments.

On the other hand if you have $2M and $500K of that is in BND, then taking the $60k a year for five years plus whatever else you need and then moving on, then there is no point in engaging in useless financial engineering.

If you have $1M and you are going through an extra $300k of it in the first five years then you are probably at a point of whatever.
I agree Miket29 explanation is helpful to understanding the question. I don't understand the above comments on "useless financial engineering" and "point of whatever"? Are you saying that with those numbers there is "enough", so the likely small differences in choices for fixed income withdrawals over 5 years don't matter?
Yes.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by phoroner »

Hi DebiT,

Lots of ways to do this. I think that the percent of your spending covered by SSA is a key variable. If high, you might feel like spending from varying bond funds is simple and easiest.

However, if you have a lot of spending not covered by SSA, you might consider building a ladder of individual TIPS to age 90 or 95 that covers your base/core spending. You then spend that money each year when the bond matures, so your return will not be subject to any market risk (interest rates or inflation) but rather locked-in now at the time of purchase. Then the rest of your fixed income is invested in bond funds. You still need to maintain a target AA that considers stock vs fixed income (funds + individual bonds) with occasional rebalancing between the stock and bond funds.

I’ve helped my father and in-laws both to set this up recently, and am happy to give more guidance. They are both happy to have more of their base spending not exposed to any market risk. And therefore more comfortable with the market risk of their stock investments.
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DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

phoroner wrote: Sat Oct 01, 2022 12:22 pm Hi DebiT,

Lots of ways to do this. I think that the percent of your spending covered by SSA is a key variable. If high, you might feel like spending from varying bond funds is simple and easiest.

However, if you have a lot of spending not covered by SSA, you might consider building a ladder of individual TIPS to age 90 or 95 that covers your base/core spending. You then spend that money each year when the bond matures, so your return will not be subject to any market risk (interest rates or inflation) but rather locked-in now at the time of purchase. Then the rest of your fixed income is invested in bond funds. You still need to maintain a target AA that considers stock vs fixed income (funds + individual bonds) with occasional rebalancing between the stock and bond funds.

I’ve helped my father and in-laws both to set this up recently, and am happy to give more guidance. They are both happy to have more of their base spending not exposed to any market risk. And therefore more comfortable with the market risk of their stock investments.
In today's dollars, in 5 years once I reach 70, my SS will cover between 60-80% of my everyday expenses, depending how I classify them (survival, hard to cut, could be cut), but not counting my $10K of discretionary, which would bring it down to 53%. So that is one variable.

I would think if I did this at all, I would do a minimal amount of TIPS, so let's say between $16K to $32K of my most essential expenses, from now until age 90, so 25 years. So does that mean I would be buying $400k-$800k of TIPS? I suspect there's something I'm not understanding right here, since my entire bond allocation past my 2 years of "cash" is about $880K

Finally, if I wanted to do this, does it or does it not matter that I would be selling BND shares at quite a loss to do this? I have been consoling myself with the idea that I will still be getting dividends, now likely to be higher, and that in a number of years, theoretically 7? the share price should come back.

Just because of the way I think, I would like very much to hear to reasons why in particular situation I should not buy TIPS, why I should just "stay the course" with BND. That helps me understand both sides of the argument.

Thanks for all the help so far while I try to understand this area that is so confusing to me.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by phoroner »

Hi DebiT,

A few comments
- the NAV of BND is down this year but the yield of the fund is up. So if you hold through the duration of the fund, you will get enough increase in income to make up for the current loss. Your post acknowledged that.
- yields in TIPS have increased a lot on 2022 also, so the same dynamic affects TIPS funds
- if you sell BND to buy a ladder of similar duration individual bonds (nominal or tips), your losses from BND will be made up by the higher yield of the individual bonds. If BND has a duration about 6.5 years, you would need to buy about a 13 year ladder to have a constant maturity. In this way, individual bonds vs a fund are similar.

If you wanted to take a portion of your bond funds in your T-IRA, and build a tips ladder, the advantage is that you would completely remove all interest rate and inflation risk for those bonds. If they are not held to maturity, then there is still interest-rate risk, which is high for long-term bonds. So, say you wanted to do a partial liability matching portfolio. You could buy 24k per year TIPS from age 70-90, which might perhaps cost 400k (i am guessing). And then the rest of your bond allocation stays invested in funds, which can be rebalanced with stock funds to maintain a total portfolio AA that you are comfortable with.

Would you be more comfortable with this set-up for your portfolio? Some are, because a higher percentage of spending is locked-in. But some find it more confusing or effort to set-up. In my opinion that is the main downside to incorporating a TIPS ladder. A TIPS ladder may also be expensive to set-up… but current rates are more attractive than they used to be.

I suspect that for many retirees, spending from a portfolio of stock & bond funds, many just take monthly/quarterly/etc distributions in a way that pushes them back to the target AA. Which is also a great way to manage things.

Ps: I had never purchased or sold an individual bond prior to 2022 but found it really easy once familiar with the basics. You can try just buying a TBill on the secondary market in your TIRA.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Dude2 »

DebiT wrote: Fri Sep 30, 2022 9:01 am
Dude2 wrote: Fri Sep 30, 2022 4:49 am If you buy TIPS you remove one risk out of a basket of bond risks, e.g. unexpected inflation risk. The person that holds a large percentage of bonds is far more exposed to this risk. If this risk show up, the money disappears, never to return. Interest rate risk is another, but, when the bond fund is held for its duration, it will generally recover. This is far different from money that disappears, never to return. Unlike stocks that have large upside potential, this is not the case for bonds. If bonds are for safety, then some people have decided that removing this one risk is important enough to take action, i.e. buy TIPS. I like the Fidelity fund FIPDX -- an index fund that holds a variety of TIPS durations, averaging to intermediate. That's a simple and lazy approach, like buying BND.

I don't want to go down the rabbit hole of a Liability Matching Portfolio, but just want to say that if TIPS are less risky than other bonds, it stands to reason that they will offer less reward. Therefore, if you are a BND holder, you are exposing yourself to other risk factors, and the idea is that you should be compensated for that. If unexpected inflation doesn't show up, then people who hold BND should get higher returns than people that hold FIPDX. I say all this because at some point people will evaluate looking backwards whether they should have been in one or the other and think themselves stupid for changing their plan; however, the point is that if you were in FIPDX vs BND you weren't exposed to unexpected inflation risk.

Note, there is an alternative consideration to all of this portfolio management for people who don't want to deal with it which is to buy annuities. If you are focused on amount of money per year to live on, then there is that path to consider, if it makes sense and you trust it versus yourself.
Thanks, this is helpful. I like your emphasis on the phrase “unexpected inflation”. Now that inflation is here, who knows for how long or not, I wonder if it is still worthwhile to buy either individual TIPS or a fund. Sigh. There is always something to figure out.
I'm very glad you got some good responses. I thought this was a decision you were making as to whether to exchange your BND for TIPS -- the relevant difference between them being that unexpected inflation concept. Only in hindsight can we know what would have been the right answer. One of the forum members, grok87, who provides some good rules of thumb for people, suggests that the larger the percentage of bonds the greater a person should consider allocation to TIPS. This is because inflation is the destroyer of bonds, and specifically this means unexpected inflation because bonds are priced with inflation in mind (that's the expected inflation part).

Although an annuity will not generally be adjusted for or indexed to inflation, the idea is that you can transfer some risks to somebody else. Picture an insurance company with deep pockets and long time horizon. They are probably very willing to make bets on market recovery, so that they will probably come out ahead. If you give them $1M, they may agree to pay you some amount for so many years. To you this may be exactly what the doctor ordered. To them they may be able to take your $1M and get a huge windfall from it. That can be a win-win for both sides of the coin. Because you seem to be focused on income per month, already having decided on some minimum figure, it is possible that an annuity of some form could transfer risk to somebody else and solve your problem. Just saying it in the context of consideration, not as an end-all-be-all type of solution.
Then ’tis like the breath of an unfee’d lawyer.
quattro73
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by quattro73 »

Where are everyone holding these TIPS?

Roth?

I am 48.

Have considered starting to add some TIPS to cover a potential Gap if I can pull off an early retirement.

The tax hit is taxable accounts seems to negate a lot of the benefit.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

quattro73 wrote: Sun Oct 02, 2022 8:27 am Where are everyone holding these TIPS?

Roth?

I am 48.

Have considered starting to add some TIPS to cover a potential Gap if I can pull off an early retirement.

The tax hit is taxable accounts seems to negate a lot of the benefit.
15 years into retirement my 401k holds nothing except an intermediate TIPS fund. A fact that allows this to make some sense is that we have about an equal amount of assets in taxable that is almost all in equities. There is also substantial income from pensions and SS. We don't have any Roth accounts.

Exactly how to allocate across assets, across account types, and to assemble a group of sources of income involves a bunch of puzzle pieces that sometimes fit together conveniently and other times are more of a quandary.

Note TIPS are more tax efficient than nominal bonds if state taxes affect you. Also note that proceeds of holding TIPS, when they are withdrawn from an IRA or 401k are just as taxable as proceeds from TIPS in a taxable account except the timing and maybe the tax rate is different, including that then state tax is paid. Conventionally a Roth account benefits the most from maximum untaxed growth, but equities in taxable may also end up with significantly untaxed growth if inherited with basis step up or gifted. There are a lot of puzzle pieces.
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by quattro73 »

Yes there are. Thanks for reply.
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DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

phoroner wrote: Sat Oct 01, 2022 5:45 pm Hi DebiT,

A few comments
- the NAV of BND is down this year but the yield of the fund is up. So if you hold through the duration of the fund, you will get enough increase in income to make up for the current loss. Your post acknowledged that.
- yields in TIPS have increased a lot on 2022 also, so the same dynamic affects TIPS funds
- if you sell BND to buy a ladder of similar duration individual bonds (nominal or tips), your losses from BND will be made up by the higher yield of the individual bonds. If BND has a duration about 6.5 years, you would need to buy about a 13 year ladder to have a constant maturity. In this way, individual bonds vs a fund are similar.

If you wanted to take a portion of your bond funds in your T-IRA, and build a tips ladder, the advantage is that you would completely remove all interest rate and inflation risk for those bonds. If they are not held to maturity, then there is still interest-rate risk, which is high for long-term bonds. So, say you wanted to do a partial liability matching portfolio. You could buy 24k per year TIPS from age 70-90, which might perhaps cost 400k (i am guessing). And then the rest of your bond allocation stays invested in funds, which can be rebalanced with stock funds to maintain a total portfolio AA that you are comfortable with.

Would you be more comfortable with this set-up for your portfolio? Some are, because a higher percentage of spending is locked-in. But some find it more confusing or effort to set-up. In my opinion that is the main downside to incorporating a TIPS ladder. A TIPS ladder may also be expensive to set-up… but current rates are more attractive than they used to be. I don't know how to determine this cost and how to determine whether it is "worth it".

I suspect that for many retirees, spending from a portfolio of stock & bond funds, many just take monthly/quarterly/etc distributions in a way that pushes them back to the target AA. Which is also a great way to manage things. How to decide when it is or is not "great enough"?

Ps: I had never purchased or sold an individual bond prior to 2022 but found it really easy once familiar with the basics. You can try just buying a TBill on the secondary market in your TIRA.
At this point, since I am grimacing every time I think of buying a TIPS ladder, it may not be right for me, at least right now. But I also recognize that I am resistant to new things, especially new things that confuse me, and I am still feeling confused. I understand to a point what TIPS do. I do not understand the parameters or variables that would make using a TIPS ladder "very desirable" vs "ehh, maybe useful" vs "in the case a bad idea". Usually when I'm trying to make a decision understanding what variables contribute to those 3 conclusions helps me.

An example that I understand to a point is AA in retirement. For example, I understand that people with a big pension plus SS who don't need withdrawals and who want to leave a big bequest might choose to be 100% in equities. I understand that people who feel they need the risk of more growth from equities might have a higher proportion of stock than someone who has "won the game" and only needs 3%, for example.

Here it seems to be more about trying to decide how concerned to be about inflation. My son the Bitcoin proponent says to be very concerned. Others who post about the amount of government debt say the same thing. In a possible 35 year retirement I would imagine it can come and go, perhaps several times.

So far I am understanding that a TIPS ladder removes the inflation concern (removes it entirely, if I'm understanding it correctly).
1. I definitely don't understand the cost, what it used to be, why it's less now, would it be even less next year to do this, etc.
2. I also don't understand what the scenarios are that would make building a TIPS ladder less desirable that my current BND/PONAX FI (80/20) with 2 years of cash in TBills. I guess that's the thing that confuses me the most. There must be scenarios where one would regret having built a TBill ladder, at least for the sake of argument. What are those?

Thanks, everyone, for your patience with my questions. This is just how my brain works when it's trying to understand something.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

DebiT wrote: Sun Oct 02, 2022 3:50 pm Hi DebiT,

1. I definitely don't understand the cost, what it used to be, why it's less now, would it be even less next year to do this, etc.

Generally there is a fixed interest rate for a TIPS and it is very small. The interest rate that matters is how much less or how much more than the face value of the bond it costs to buy the bond. It is an interest rate because the getting back or not getting back of that money is calculated as if getting or paying interest. This is the reason a TIPS ladder is cheaper now when you can buy them at TD auction or on the market for less than you will get back in real dollars. The TIPS real yield has gone from around -1.5% to around +1.5% but no one knows what it will be a year from now. A calculation of the impact of the real yield at purchase is that a 30 year TIPS ladder bought at face value will give you back 3.33% of your investment inflation indexed each year. At -1.5% I think it is more like 2.7% and at +1.5% more like 4.1%.

2. I also don't understand what the scenarios are that would make building a TIPS ladder less desirable that my current BND/PONAX FI (80/20) with 2 years of cash in TBills. I guess that's the thing that confuses me the most. There must be scenarios where one would regret having built a TBill ladder, at least for the sake of argument. What are those?

Scenarios have to be whole pictures including all your assets, your income streams, your spending, your overall objectives, and so on. I would say your question can't be answered in a simple way and like most questions about fixed income the future is so unknown or we could say the range of possible outcomes for any plan is so wide that there are almost no definitive choices to prefer over other choices. You switched from TIPS to T-bills. Is that on purpose? A general reason to own TIPS is that it makes sense for retirees who no longer earn large income to try to take that hazard out of part of their resources. Whether or not a TIPS ladder is really helpful or not as a general instrument for retirement income, I have no idea. If you are really asking about a short ladder of T-bills, for the long term investor I don't see any real point to it. My parents, well into retirement, finally sold their home and rented. The proceeds of the sale went into T-bills, not a ladder, just rolled over, and that was a stash of cash to pay rent and so on. They were getting 6% interest in those days.

Thanks, everyone, for your patience with my questions. This is just how my brain works when it's trying to understand something.
Topic Author
DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

I'm sorry for the confusion. I didn't switch from TIPS to TBills. I was describing my current FI allocation, which is mostly BND, and 2 years in TBills. I am planning on a possible 35 year retirement to age 100 so that is my time frame.

My OP noted my total portfolio value, and my residual spending after SS. That's currently $60 residual, going down to $44K in 5 years when I claim my own benefit. A later reply of mine noted that if I were buying a TIPS ladder I would probably only be concerned with $12-24K as being absolutely necessary. I said " In today's dollars, in 5 years once I reach 70, my SS will cover between 60-80% of my everyday expenses, depending how I classify them (survival, hard to cut, could be cut), but not counting my $10K of discretionary, which would bring it down to 53%. " That may be faulty thinking or a reluctance to go fully into TIPS.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
miket29
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by miket29 »

DebiT wrote: Sun Oct 02, 2022 3:50 pm So far I am understanding that a TIPS ladder removes the inflation concern (removes it entirely, if I'm understanding it correctly).
1. I definitely don't understand the cost, what it used to be, why it's less now, would it be even less next year to do this, etc.
2. I also don't understand what the scenarios are that would make building a TIPS ladder less desirable that my current BND/PONAX FI (80/20) with 2 years of cash in TBills. I guess that's the thing that confuses me the most. There must be scenarios where one would regret having built a TBill ladder, at least for the sake of argument. What are those?
Regarding (1) I think it may be referring to the yields on TIPS. Even this past spring they were negative on many maturities. For example the 5 year bond had a YTM of about -1% which meant that over the 5 years you were going to lose 5% of your purchase in real dollars. Many people were reluctant to buy TIPS with negative yields although with BND down more than 14% this year it might turn out to be better that holding BND (depending on what return BND earns in the remaining 4.5 years or so and what inflation does)

Regarding (2) and regret for building a ladder, not all ladders are the same. I'm leery of going out much longer than 5-7 years because life happens. If I were to need to spend some of my bond holdings unexpectedly and they are in a ladder, what I can sell them for depends on the interest rates at the time. It's my understanding that the bond duration of a TIPS bond is somewhere near the time left to maturity. So a TIPS maturing in 10 years could have a duration of 8-9 years. If interest rates are up 2% then the bond would be down 15% or more in value. With a 20-year ladder many of the bonds would be in the longer durations so it would be a double-whammy -- needing the money earlier than hoped and possibly at a significant loss. It's a risk I personally don't want to take but others can choose differently.
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

miket29 wrote: Sun Oct 02, 2022 6:09 pm
DebiT wrote: Sun Oct 02, 2022 3:50 pm So far I am understanding that a TIPS ladder removes the inflation concern (removes it entirely, if I'm understanding it correctly).
1. I definitely don't understand the cost, what it used to be, why it's less now, would it be even less next year to do this, etc.
2. I also don't understand what the scenarios are that would make building a TIPS ladder less desirable that my current BND/PONAX FI (80/20) with 2 years of cash in TBills. I guess that's the thing that confuses me the most. There must be scenarios where one would regret having built a TBill ladder, at least for the sake of argument. What are those?
Regarding (1) I think it may be referring to the yields on TIPS. Even this past spring they were negative on many maturities. For example the 5 year bond had a YTM of about -1% which meant that over the 5 years you were going to lose 5% of your purchase in real dollars. Many people were reluctant to buy TIPS with negative yields although with BND down more than 14% this year it might turn out to be better that holding BND (depending on what return BND earns in the remaining 4.5 years or so and what inflation does)

Regarding (2) and regret for building a ladder, not all ladders are the same. I'm leery of going out much longer than 5-7 years because life happens. If I were to need to spend some of my bond holdings unexpectedly and they are in a ladder, what I can sell them for depends on the interest rates at the time. It's my understanding that the bond duration of a TIPS bond is somewhere near the time left to maturity. So a TIPS maturing in 10 years could have a duration of 8-9 years. If interest rates are up 2% then the bond would be down 15% or more in value. With a 20-year ladder many of the bonds would be in the longer durations so it would be a double-whammy -- needing the money earlier than hoped and possibly at a significant loss. It's a risk I personally don't want to take but others can choose differently.
Exactly. These are really good points. The extreme would be to go out and buy an annuity. Then the money is gone. But the capital risk is now zero because the capital is worth exactly zero from then on. Actually some annuities and even pensions can be sold, but now the price varies with the prevailing interest rates. But then the purchase depended on where variable interest rates sat when the annuity was purchased. The same applies to taking pension lump sums instead of a pension.
Topic Author
DebiT
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by DebiT »

miket29 wrote: Sun Oct 02, 2022 6:09 pm
DebiT wrote: Sun Oct 02, 2022 3:50 pm So far I am understanding that a TIPS ladder removes the inflation concern (removes it entirely, if I'm understanding it correctly).
1. I definitely don't understand the cost, what it used to be, why it's less now, would it be even less next year to do this, etc.
2. I also don't understand what the scenarios are that would make building a TIPS ladder less desirable that my current BND/PONAX FI (80/20) with 2 years of cash in TBills. I guess that's the thing that confuses me the most. There must be scenarios where one would regret having built a TBill ladder, at least for the sake of argument. What are those?
Regarding (1) I think it may be referring to the yields on TIPS. Even this past spring they were negative on many maturities. For example the 5 year bond had a YTM of about -1% which meant that over the 5 years you were going to lose 5% of your purchase in real dollars. Many people were reluctant to buy TIPS with negative yields although with BND down more than 14% this year it might turn out to be better that holding BND (depending on what return BND earns in the remaining 4.5 years or so and what inflation does)

Regarding (2) and regret for building a ladder, not all ladders are the same. I'm leery of going out much longer than 5-7 years because life happens. If I were to need to spend some of my bond holdings unexpectedly and they are in a ladder, what I can sell them for depends on the interest rates at the time. It's my understanding that the bond duration of a TIPS bond is somewhere near the time left to maturity. So a TIPS maturing in 10 years could have a duration of 8-9 years. If interest rates are up 2% then the bond would be down 15% or more in value. With a 20-year ladder many of the bonds would be in the longer durations so it would be a double-whammy -- needing the money earlier than hoped and possibly at a significant loss. It's a risk I personally don't want to take but others can choose differently.
Thank you. I hadn't thought about that scenario. That's exactly what I don't want. I begin to see how it's a very personal decision, and includes not just my personal portfolio math, but my personality as well. I do not like loss of control over my assets. I already know that choosing to buy an annuity, even 20 years from now, would be hard. So for practical purposes, ladder money would be locked up, in the sense that it would a costly mistake to have to sell early. I would have to be sure there was still plenty of a fixed income allocation left for emergencies, in order to be comfortable doing this.

Good food for thought.
Age 66, life turned upside down 3/2/19, thanking God for what I've learned from this group. AA 40/60 for now, possibly changing at age 70.
Dude2
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Dude2 »

DebiT wrote: Sun Oct 02, 2022 8:12 pm I do not like loss of control over my assets. I already know that choosing to buy an annuity, even 20 years from now, would be hard. So for practical purposes, ladder money would be locked up, in the sense that it would a costly mistake to have to sell early. I would have to be sure there was still plenty of a fixed income allocation left for emergencies, in order to be comfortable doing this.

Good food for thought.
There are some posters with beaucoup discipline who have gone the TIPS LMP route. I totally respect that. Generally people can't afford to do that. They have to take their chances with a risk portfolio. Caution needs to be expressed that just because everybody is doing it (has to do it) doesn't change the definition of risk. What is the point of being rich when you still have to take risk along with everybody else? Therefore, these really smart few have figured out the solution to the problem we are all trying to solve -- to provide income for ourselves in retirement. A TIPS LMP is that solution. If only we could all do it...

From this perspective, your money isn't locked up anymore than your social security money is locked up (assuming enough years of LMP). It is just waiting to be paid out to you, and you don't lose any sleep over it not being there.

We shouldn't be distracted away from solving the problem, as discussed by Merton
https://robertcmerton.com/wp-content/up ... Merton.pdf

Don't get me wrong, we will always have the problem (risk) of needing more money than we have, but the idea is to make retirement life no different than working life. Retirees with huge pensions I don't think are worriers, and we all would want that for ourselves. Clearly everybody's individual pot of gold and life circumstances are different, but if a person is interested in TIPS as a tool then trying to get across the use for such a tool in a larger context.
Then ’tis like the breath of an unfee’d lawyer.
PoemMan
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by PoemMan »

This discussion is very informative - thank you.

A few questions:

Dude2 suggested early in this thread the use of Fidelity’s FIPDX as a simple means of owning TIPS. What would be the difference(s) between that fund and setting up a TIPS ladder (other than simplicity)?

For a ladder, would the TIPS be likely purchased on the secondary market, as it seems is possible via Fidelity?

What is a “long TIP”? Greater than say 5 years? Is there a threshold that is too long? (e.g. beyond the planning period) Is a TIPS ladder simply a series of long TIPS maturing annually or another frequency?

miket29 indicated an uneasiness with TIPS extending longer than 5~7 years. While I understand the reasoning (but not the math of maturity and duration), wouldn’t that defeat the purpose of using TIPS (protecting against inflation)? And if limited to this shorter time period, what would be the replacement inflation hedge?

Our expenses are 50/50 inflation sensitive/insensitive, suggesting that if TIPS are used, at least ~50% of fixed income assets could (should) be in TIPS.

Thank you,
PoemMan
“This old truck … I own it … it don’t own me” - Howlin’ Wolf in Cadillac Records
phoroner
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by phoroner »

Hi PoemMan,

Common use would be long-term bond is over 10 years, intermediate is 5-10 years, and short is less than 5 years… Give or take. There are differences of opinion on optimal duration- some like to stay to short or intermediate to reduce principal fluctuations while others match total spending duration. Different views of risks and goals, I guess.

There have been lots of discussions of use of bond ladders vs funds; you can search for them. The Wiki has a nice page on this. In general, if you have a ladder where you roll over maturing bonds into new ones AND match the overall duration, there is no difference. If you have a non-rolling ladder where bonds are spent on maturity, this can be copied with funds by gradually reducing the duration. So with Treasurys (nominal or TIPS), it is a matter of preference. Funds are simpler to use but a ladder automatically reduces its duration. With municipal or corporate bonds, fund are generally superior to diversify issuer-related risks.

I agree that short-term TIPS aren’t as valuable as intermediate- or long-term because inflation presents more of a long-term risk to fixed-income holders.
Dude2
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by Dude2 »

#Cruncher has detailed analysis on Consistent Yield & Duration to Help Choose TIPS Fund

Vineviz will tell us that the rule is to have the duration match the need of the money to eliminate interest rate risk. Therefore, if the need is long, the recommendation is to be long. Using a rule like this takes market timing of the best duration out of the consideration. Nobody can really argue with the logic of this.

When the yield curve is not flat, people are rewarded by buying long, and the yield curve is generally not flat. Those of us that stick with short or intermediate duration (and have a need that is further out) are missing out on higher real yields and corresponding exponential growth (if you think big-picture, long term).

Anyway, that's the thinking. Yes, you can modulate a long TIPS with a short TIPS fund to get you the duration you need. You don't have to buy individual bonds.

The only thing with long bonds is their value volatility, but the truth of their value is complicated. Everything is always relative to something else. We buy bonds for safety. They are a tool in the toolbox. There is a behavioral component to holding long bonds in the face of so much volatility which is why people tend to group up into intermediate bonds. So, I would be a guy that uses FIPDX as a simple approach, but that is not optimal.
Then ’tis like the breath of an unfee’d lawyer.
PoemMan
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by PoemMan »

Thank you phoroner and Dude2.

If intermediate and/or long-term TIPS are better, and it appears that FIPDX's (weighted) avg maturity and duration are 7.3 and 7.13 years respectively, then it appears that that particular fund is intermediate.

Now for more questions ... if TIPS are purchased with duration in mind (short, intermediate or long-term) for one's circumstances and cashed out for use (at maturity?), then how is a TIPS fund (like FIPDX) utilized? Given its current duration and maturity as above, in ~7 years (or even in the intervening 0-7 years) will the fund have a different duration/maturity, or close to the same? Does that render the duration and maturity attributes a "rolling wave" throughout the fund's life with varying values?

Thanks again,
PoemMan
“This old truck … I own it … it don’t own me” - Howlin’ Wolf in Cadillac Records
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

PoemMan wrote: Fri Oct 07, 2022 9:51 pm Thank you phoroner and Dude2.

If intermediate and/or long-term TIPS are better, and it appears that FIPDX's (weighted) avg maturity and duration are 7.3 and 7.13 years respectively, then it appears that that particular fund is intermediate.

Now for more questions ... if TIPS are purchased with duration in mind (short, intermediate or long-term) for one's circumstances and cashed out for use (at maturity?), then how is a TIPS fund (like FIPDX) utilized? Given its current duration and maturity as above, in ~7 years (or even in the intervening 0-7 years) will the fund have a different duration/maturity, or close to the same? Does that render the duration and maturity attributes a "rolling wave" throughout the fund's life with varying values?

Thanks again,
PoemMan
Funds maintain constant duration and maturity more or less and are used in conjunction with stocks to set a portfolio at some desired neighborhood of risk and return kept fixed for the long run. When retired they are an appropriate match for supporting continuous small withdrawals over an extended time. Probably a lot of people just pick intermediate duration and go away. For longer terms people might hold some longer bond funds. This kind of planning does not have shorter terms so possibly short bond funds would not be used except as a balance to long bonds.

An example of an alternative approach to supplying income in retirement would be a ladder of long TIPS with a rung maturing in each year for spending, noting that such a ladder comes to an end at the last year. Rolling ladders are not different from funds. It is not evident that rebalanced stock/bond allocations or combinations of stocks with annuities or with TIPS ladders are significantly different in overall outcome.
FCM
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by FCM »

I also want to understand something related to the Vanguard TIPS fund VIPSX (intermediate term with a duration of 7.2 years), which I have in my Roth IRA. As of 10/8/22 the fund shows a price per share of $11.94, and the stated SEC yield is 1.36%. However, the distributions per share for the last 12 months have been as follows:

12/23/21 - $0.92/share
4/1/22 - $0.15/share
7/1/22 - $0.31/share
10/3/22 - $0.21/share

Total distribution for the last 12 months: $0.96/share, which includes the annual inflation adjustment that was paid out 12/23/21. Thus, the distribution yield seems to be around 8% based upon a 12 month $0.96/share distribution compared to the 10/8/22 price of $11.94. The quoted SEC yield of 1.36% apparently doesn't include the annual inflation adjustment, but in reality it's still something that's paid out annually, the amount depending upon the CPI for the year, which I know can vary from year-to-year. Assuming that the CPI adjustment for December 2022 will be at least what it was for 2021 and that inflation adjustments over the next few years MIGHT be something approximating what was paid out on 12/23/21, shouldn't the anticipated yield on VIPSX be closer to 8% at least for the next few years, assuming inflation remains about where it is today? I know that's a big assumption, but it seems somewhat reasonable. What am I missing?
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

FCM wrote: Sat Oct 08, 2022 8:52 am I also want to understand something related to the Vanguard TIPS fund VIPSX (intermediate term with a duration of 7.2 years), which I have in my Roth IRA. As of 10/8/22 the fund shows a price per share of $11.94, and the stated SEC yield is 1.36%. However, the distributions per share for the last 12 months have been as follows:

12/23/21 - $0.92/share
4/1/22 - $0.15/share
7/1/22 - $0.31/share
10/3/22 - $0.21/share

Total distribution for the last 12 months: $0.96/share, which includes the annual inflation adjustment that was paid out 12/23/21. Thus, the distribution yield seems to be around 8% based upon a 12 month $0.96/share distribution compared to the 10/8/22 price of $11.94. The quoted SEC yield of 1.36% apparently doesn't include the annual inflation adjustment, but in reality it's still something that's paid out annually, the amount depending upon the CPI for the year, which I know can vary from year-to-year. Assuming that the CPI adjustment for December 2022 will be at least what it was for 2021 and that inflation adjustments over the next few years MIGHT be something approximating what was paid out on 12/23/21, shouldn't the anticipated yield on VIPSX be closer to 8% at least for the next few years, assuming inflation remains about where it is today? I know that's a big assumption, but it seems somewhat reasonable. What am I missing?
You are missing that real and nominal are two different things. Vanguard publishes an SEC real yield and you computed a nominal distribution yield in dollars before inflation. Unfortunately there is no free lunch. If you withdraw and spend the inflation increment the Treasury just handed out, your holding will not be inflation protected. You have to reinvest the inflation part but you can spend the real interest. The origin of the real yield is that TIPS are sold by the Treasury at a discount and you get to cash in the discount when the bond matures. It could be worse. If you hold nominal bonds you don't even get the inflation increment. The yield on nominal bonds might be 4%, but that is a real yield of -4% when there is 8% inflation. To inflation protect a nominal bond you would have to reinvest the 4% and add another 4% every year to keep up.
PoemMan
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by PoemMan »

Thank you dbr for these.

You said
If you withdraw and spend the inflation increment the Treasury just handed out, your holding will not be inflation protected. You have to reinvest the inflation part but you can spend the real interest.
From an implementation perspective, does that mean I would determine the real interest portion earned in (my case FIPDX) each quarter (or other periodicity), assess whether that is sufficient to cover RLEs, and if not, cover them from elsewhere?

If this is true, then it seems a mixture of a TIPS fund + others (e.g. Total US Bond Mkt FXNAX, CDs, annuities, etc.) would be appropriate to enable making up the difference between need and TIPS fund $ available from earned real interest.

I may be overthinking this, but isn't that the purpose of the inflation increment, to cover costs/expenses that have increased due to inflation? Or is the purpose to keep the principle in pace with inflation, then withdraw from that in lieu of the inflation increment?

Currently I withdraw and don't consider these details, only to rebalance as possible. (portfolio currently has only FXNAX, FSKAX and FTIHX)

PoemMan
“This old truck … I own it … it don’t own me” - Howlin’ Wolf in Cadillac Records
dbr
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Re: Fixed income portfolio review for newish retiree who doesn't understand TIPs

Post by dbr »

PoemMan wrote: Sun Oct 09, 2022 8:36 am
I may be overthinking this, but isn't that the purpose of the inflation increment, to cover costs/expenses that have increased due to inflation? Or is the purpose to keep the principle in pace with inflation, then withdraw from that in lieu of the inflation increment?


PoemMan
The purpose of the inflation increment is to allow the principal to pace inflation. Once you operate in terms of real return then the real yield is what matters combined with not depleting the portfolio too fast in real dollars by combining withdrawals with poor returns. TIPS investors are now better off because real yields have gone from negative to positive. At the same time term risk (interest rate risk, duration risk) has reared its ugly head, but that is a price you pay for getting into a healthier range on real yield. It takes time for total value to recover.

So, to emphasize, the accounting depends on return and withdrawals, which together determine the growth or depletion of the portfolio. The significance of TIPS is to have that bookkeeping going on explicitly in real values, real withdrawals, and real return. Any retirement planning model from FireCalc on up does the bookkeeping in real dollars, which is why the safe withdrawal rate model usually is done in the context of withdrawals being an inflation indexed fraction of initial portfolio value and data input is nominal returns and inflation to compute real gains and real returns.

An example is here: https://engaging-data.com/visualizing-4-rule/ The default setting is inflation indexed everything. The FireCalc model also includes pensions and annuities and allows setting as inflation indexed such as Social Security or fixed dollar such as a typical SPIA and many pensions. It is always a more complicated analysis when some components of the plan are inflation indexed, such as spending, Social Security, and real returns and some parts are fixed, such as a fixed pension.
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