VTIP vs TIPS Bonds ETF Ladder

[canisius]

I don't know much about the latter, so advanced apologies for sounding ignorant.

I currently have 10% of my portfolio in VTIP (Roth IRA).  After speaking with a friend, they mentioned they try to mimic TIPS laddering by using a ladder of iShares TIPS Bond ETFs. 

Is there any benefit to trying that over one fund or is it just overcomplicating something?

Thanks!

[vand]

TIPS should all come with a massive "caveat emptor" as 99% of people who own them don't own what they think they own (an inflation hedge).

[bacchi]

TIPS should all come with a massive "caveat emptor" as 99% of people who own them don't own what they think they own (an inflation hedge).

How so?


OP: Match your duration with actual TIPS on the secondary market. It takes more effort than buying laddered ETFs but it more accurately aligns with your needs.

[ChpBstrd]

I’ll second @bacchi .

Only buy as much duration as you need. Just directly buy individual bonds to do so. Heed the lesson of 2022. It’s not an effective inflation hedge if it’s wiped out by rate hikes.

[BicycleB]

TIPS should all come with a massive "caveat emptor" as 99% of people who own them don't own what they think they own (an inflation hedge).

@vand, why aren't TIPS an inflation hedge?

Or are you saying they're an inflation hedge, but 99% of buyers fail to receive the hedge because of some mistake?

[vand]

TIPS should all come with a massive "caveat emptor" as 99% of people who own them don't own what they think they own (an inflation hedge).

@vand, why aren't TIPS an inflation hedge?

Or are you saying they're an inflation hedge, but 99% of buyers fail to receive the hedge because of some mistake?

Yes, 2 points:

First, they are still primarily bonds at the end of the day. They can't protect you from *unexpected* inflation, or if real yields rise.

And, if you buy them when inflation expectations are high, and actual inflation comes in lower, you can lose out that way.

S&P U.S. TIPS 1-3 Year Index went down in 2022
https://www.spglobal.com/spdji/en/indices/fixed-income/sp-us-tips-1-3-year-index/#overview

Likewise, Vanguard's VTIP fund with an average duration of 2.5 years did not keep up with inflation during 2022-23 - due to the higher real yields.


Second, same with any long dated bond fund, they can be very volatile in the short term and many people will buy a long duration fund just thinking they protect you against inflation in any environment without having an appreciation for the interest rate risk they are taking on.

[BicycleB]

TIPS should all come with a massive "caveat emptor" as 99% of people who own them don't own what they think they own (an inflation hedge).

@vand, why aren't TIPS an inflation hedge?

Or are you saying they're an inflation hedge, but 99% of buyers fail to receive the hedge because of some mistake?

Yes, 2 points:

First, they are still primarily bonds at the end of the day. They can't protect you from *unexpected* inflation, or if real yields rise.

And, if you buy them when inflation expectations are high, and actual inflation comes in lower, you can lose out that way.

S&P U.S. TIPS 1-3 Year Index went down in 2022
https://www.spglobal.com/spdji/en/indices/fixed-income/sp-us-tips-1-3-year-index/#overview

Likewise, Vanguard's VTIP fund with an average duration of 2.5 years did not keep up with inflation during 2022-23 - due to the higher real yields.


Second, same with any long dated bond fund, they can be very volatile in the short term and many people will buy a long duration fund just thinking they protect you against inflation in any environment without having an appreciation for the interest rate risk they are taking on.

I didn’t read the link because the permissions require social media sharing. But I have always read the IPS in TIPS stands for Inflation Protected Securities. Why doesn’t the inflation protection work?

“They’re bonds” doesn’t seem like a clear answer. I understand that a fixed rate bond’s value will change when the interest rate environment changes. But the point of TIPS is that they’re not “fixed”, isn’t it?

I read elsewhere (sample link below) that every six months, the US Treasury adjusts the face value of the bond in accordance with the inflation rate, and that the interest on TIPS is proportional to the face value. Shouldn’t they behave differently from fixed rate bonds?

https://www.investopedia.com/terms/t/tips.asp

I held VTIP briefly in early 2022 and did observe its value falling when interest rates went up. Maybe the value changed because of the 6 months before adjustment rates, or because of fund details like redemptions?

It seems like the individual bonds should adjust as specified, with the result being to in fact largely be protected against inflation. If “real yields rise” in the overall market, I’d expect that holding to maturity would work as specified in the bond’s terms. In the event of selling, I see your point that yields of other bonds could rise more than inflation, reducing the sale price relative to the unadjusted component of the bond, but if inflation were rising at the time, there should be an advantage due to the inflation adjustment.


I guess it’s hard to calculate the result without projecting both factors?

[bacchi]

Unexpected inflation is what happened in 2021-2023. Expected inflation is what we usually get: 2-3%.

TIPS are still bonds and the real yield (fixed yield - inflation) is important when rates rise. In other words, the TIPS fixed rate that was ok when you bought it in 2019, [plus the inflation adjustment], is less than a regular bond bought in 2022. Hence TIPS on the secondary market look less attractive. Note that this can change quickly if inflation keeps rising and another rate increase is slow in arriving.

This doesn't matter if you hold individual bonds that are duration matched. That is, if you hold a bond maturing in 2026, you'll receive exactly what you expect: the fixed rate + the inflation adjustment. You shouldn't care about how much the bond is priced on the secondary market unless you have to sell early.


Edit: [Clarification]

[vand]

Unexpected inflation is what happened in 2021-2023. Expected inflation is what we usually get: 2-3%.

TIPS are still bonds and the real yield (fixed yield - inflation) is important when rates rise. In other words, the TIPS fixed rate that was ok when you bought it in 2019, [plus the inflation adjustment], is less than a regular bond bought in 2022. Hence TIPS on the secondary market look less attractive. Note that this can change quickly if inflation keeps rising and another rate increase is slow in arriving.

This doesn't matter if you hold individual bonds that are duration matched. That is, if you hold a bond maturing in 2026, you'll receive exactly what you expect: the fixed rate + the inflation adjustment. You shouldn't care about how much the bond is priced on the secondary market unless you have to sell early.


Edit: [Clarification]

But: how do you know how long the inflationary period will last?  It's all very well in hindsight saying that if you held individual 2yr TIPS over the period of 2yrs where inflation went from 2% to 10% then back to 2%they would have protected you... But nobody has this clairvoyance.   You might have reasonably held 1yr tips and then when those matured had to roll them over at a higher real yield, hence losing that way.  There is no magic protection in holding individual securities unless you know for sure the path of inflation and real yields!

[bacchi]

Unexpected inflation is what happened in 2021-2023. Expected inflation is what we usually get: 2-3%.

TIPS are still bonds and the real yield (fixed yield - inflation) is important when rates rise. In other words, the TIPS fixed rate that was ok when you bought it in 2019, [plus the inflation adjustment], is less than a regular bond bought in 2022. Hence TIPS on the secondary market look less attractive. Note that this can change quickly if inflation keeps rising and another rate increase is slow in arriving.

This doesn't matter if you hold individual bonds that are duration matched. That is, if you hold a bond maturing in 2026, you'll receive exactly what you expect: the fixed rate + the inflation adjustment. You shouldn't care about how much the bond is priced on the secondary market unless you have to sell early.


Edit: [Clarification]

But: how do you know how long the inflationary period will last?  It's all very well in hindsight saying that if you held individual 2yr TIPS over the period of 2yrs where inflation went from 2% to 10% then back to 2%they would have protected you... But nobody has this clairvoyance.   You might have reasonably held 1yr tips and then when those matured had to roll them over at a higher real yield, hence losing that way.  There is no magic protection in holding individual securities unless you know for sure the path of inflation and real yields!

Maybe we're speaking past each other re: "duration matched" bonds. My laddered TIPS expire each year because I need the cash for living expenses. Why would I need to roll them? The duration is matched to my investment horizon.

The 2015 10 year was ~2%, while the TIPS was ~0.7%. The (fixed yield + adjustment) would've never been below 2% for the life of the TIPS. Meanwhile, the 2% fixed bond is losing purchasing power every year. That won't happen every time -- as Joe Dominguez (YMOYL) proved with his 14% yields -- but they have a purpose and that is to mitigate a 1966 retirement fail.

[forummm]

They can't protect you from *unexpected* inflation.

Actually, that's exactly what they protect you from. The market price today includes expected inflation and the risk free rate combined into the yield. You're buying a specific guaranteed real rate of return.

If inflation comes in lower than market expectation you would have done better buying regular Treasuries. If inflation comes in higher than expected you do better with TIPS than with regular Treasuries.

The market price of any bond can change when interest rates change. So when inflation started running hot a few years ago, and the Fed started raising rates quickly, TIPS prices went *down*--but down a lot less than regular Treasuries did.

But if you hold TIPS to maturity, you receive a guaranteed real rate of return--which is an inflation hedge.