Author Topic: TIPS or no TIPS?  (Read 9598 times)

joer1212

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TIPS or no TIPS?
« on: February 28, 2013, 04:46:10 PM »
Given a choice, would you rather put TIPS (VIPSX) in a taxable account, and deal with
the tax ramifications every year, or not have them at all in your portfolio?

This is the decision I must make. I have no space left in my Roth IRA (which contains REITs), so if I want TIPS they would have to go into my taxable account (my employee plans don't offer them)


I currently have:

In my 401k/457b:
25% Total bond index fund (State Street advisers; SSgA)


Roth IRA:
10% REITs (VGSIX)



Taxable brokerage account:
44% Total stock market index fund (VTSAX)
21% Total international index fund (VTIAX)


Right now I am 75% stocks/25% bonds, but if and when I add TIPS, I would like to bring my AA to 70% stocks/30% bonds


FYI:
-I max out all 3 of my tax-advantaged accounts every year (40.5k)
-My net worth is 149k.
-About 16k of my money is in cash in a high-yield checking account
-I live in Brooklyn, New York.
-I am 43 years-old
« Last Edit: February 28, 2013, 04:53:40 PM by joer1212 »

KingCoin

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Re: TIPS or no TIPS?
« Reply #1 on: February 28, 2013, 05:09:36 PM »
I'm not a huge fan. If we get 2.5% inflation, 10y TIPS will yield you about 1.8%. Fully taxable. Not too hot.

They'll do well if we some unexpected inflation, but overall, I prefer long dated, fixed coupon treasuries as a disaster hedge. You're heavy enough in equities that you should be protected against inflation long-term.

joer1212

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Re: TIPS or no TIPS?
« Reply #2 on: February 28, 2013, 05:33:21 PM »
Quote
I'm not a huge fan. If we get 2.5% inflation, 10y TIPS will yield you about 1.8%. Fully taxable. Not too hot.

They're not fully taxable. They are state and local tax-free, except (I think) on the inflation adjustment. Correct me if I'm wrong.


KingCoin

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Re: TIPS or no TIPS?
« Reply #3 on: February 28, 2013, 05:42:12 PM »


They're not fully taxable. They are state and local tax-free, except (I think) on the inflation adjustment. Correct me if I'm wrong.

You're right. Federal only.

brewer12345

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Re: TIPS or no TIPS?
« Reply #4 on: February 28, 2013, 06:46:02 PM »
Actually, I think that TIPS are a very nice diversifier for a portfolio.  They provide unique insurance against a nasty inflationary cycle, which I think is a bigger, more damaging risk than deflation in the present.  The problem with TIPS is that they are presently quite expensive.  The alternatives I have been using are I bonds (limited to what you can put into them) and a TIPS closed end fund selling at a big discount to NAV, ticker WIW.  I have a reasonably detailed write-up on WIW here (but do your own due diligence): http://lifeinvestmentseverything.blogspot.com/2013/01/wiw-another-dollar-selling-for-90-cents.html

John74

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Re: TIPS or no TIPS?
« Reply #5 on: February 28, 2013, 08:06:47 PM »
TIPS yes. But not at at these prices.

I held TIPS in a taxable account before. Not much of a pain to deal with at tax time. If real interest rates go back up near 2% on the 30-year TIPS, I will get back in.

KingCoin

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Re: TIPS or no TIPS?
« Reply #6 on: February 28, 2013, 09:53:04 PM »
When you factor in the management fee, these "cheap to NAV" closed end funds often start looking less interesting. Take, WIW. It's management fee is about 50bps higher than comparable Vanguard. Multiply that by a duration of 10yrs, and all of a sudden it's only 5% cheap to NAV instead of 10%. Now consider that the fund is only 70% TIPs along with 12% cash and other assorted bonds.  In times of distress, the discount to NAV is likely to increase, making it a poor hedge (one of the primary purposes of treasuries). It's not to say this fund is awful, but given it's drawbacks, it's probably not too compelling.

It's worth underscoring that TIPs have NEGATIVE REAL YIELDS. You are paying money for the privilege of reproducing inflation (i.e. you will underperformed inflation). If you have a decent horizon, things like stocks and real estate are better assets.

joer1212

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Re: TIPS or no TIPS?
« Reply #7 on: February 28, 2013, 11:17:30 PM »
When you factor in the management fee, these "cheap to NAV" closed end funds often start looking less interesting. Take, WIW. It's management fee is about 50bps higher than comparable Vanguard. Multiply that by a duration of 10yrs, and all of a sudden it's only 5% cheap to NAV instead of 10%. Now consider that the fund is only 70% TIPs along with 12% cash and other assorted bonds.  In times of distress, the discount to NAV is likely to increase, making it a poor hedge (one of the primary purposes of treasuries). It's not to say this fund is awful, but given it's drawbacks, it's probably not too compelling.

It's worth underscoring that TIPs have NEGATIVE REAL YIELDS. You are paying money for the privilege of reproducing inflation (i.e. you will underperformed inflation). If you have a decent horizon, things like stocks and real estate are better assets.

So, does this mean that I shouldn't buy TIPS 'for now'?  Should I jump back into TIPS in the future?
I have an indexing investing philosophy, so this seems kind of anathema to that. Wouldn't it be "timing the market" if I wait for the "right time" to jump in?
I would think that TIPS are either worthy of being included in one's asset allocation, or they're not. If they are not good now, they should not be good at anytime.

KingCoin

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Re: TIPS or no TIPS?
« Reply #8 on: February 28, 2013, 11:59:49 PM »
So, does this mean that I shouldn't buy TIPS 'for now'?  Should I jump back into TIPS in the future?
I have an indexing investing philosophy, so this seems kind of anathema to that. Wouldn't it be "timing the market" if I wait for the "right time" to jump in?
I would think that TIPS are either worthy of being included in one's asset allocation, or they're not. If they are not good now, they should not be good at anytime.

I don't have a problem with TIPS in theory (despite the minor paranoid quibble that CPI is calculated by a government agency - see Argentina for a example of how this can go horribly wrong). Right now however, your money is basically guaranteed to lose 0.60% per year in in real terms to maturity (they're yielding inflation -60bps). That's a tough pill to swallow if you don't need to be defensive.

I appreciate your thinking on portfolio construction that doesn't attempt to game current asset levels. Once you open those floodgates, it's easy to make a lot of mistakes trying to be "smart". If you read the bond bubble thread, I was fairly defensive on treasuries as a disaster hedge, despite their historical richness. My personal preference is an all long dated fixed coupon treasury allocation. Why? I think treasuries are almost exclusively useful as an economic hedge at current valuations, and fixed coupons get a better pop when things go wrong (and will also beats TIPS if we hit a deflationary Japan style patch). Over the long term, real estate and stocks should keep your inflation bases covered.  If you were twenty years older, and needed shorter term inflation protection shielded from market volatility, I might be more inclined toward TIPS.

All that being said, I don't think including some TIPS is a "mistake", just a highly defensive position that you'll end up partially allocating to stocks if we see a market crash.

tooqk4u22

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Re: TIPS or no TIPS?
« Reply #9 on: March 01, 2013, 07:49:01 AM »
Ignoring whether or not they are good investments now and back to the OP question - I wouldn't hold them in a taxable account. If you do want some of this investment in your portfolio do when you add to your roth/401k or realocate some of the existing bonds into TIPS.   

brewer12345

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Re: TIPS or no TIPS?
« Reply #10 on: March 01, 2013, 08:01:37 AM »
When you factor in the management fee, these "cheap to NAV" closed end funds often start looking less interesting. Take, WIW. It's management fee is about 50bps higher than comparable Vanguard. Multiply that by a duration of 10yrs, and all of a sudden it's only 5% cheap to NAV instead of 10%. Now consider that the fund is only 70% TIPs along with 12% cash and other assorted bonds.  In times of distress, the discount to NAV is likely to increase, making it a poor hedge (one of the primary purposes of treasuries). It's not to say this fund is awful, but given it's drawbacks, it's probably not too compelling.


Heh, my holding period will likely be two years or so.  For the last several years I have been making double digit returns with closed end funds in a fairly low risk manner.  Methodology here: http://lifeinvestmentseverything.blogspot.com/2012/01/how-to-buy-dollar-for-90-cents.html

KingCoin

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Re: TIPS or no TIPS?
« Reply #11 on: March 01, 2013, 09:41:37 AM »
Heh, my holding period will likely be two years or so.

The holding period is irrelevant. The management fee is a largely durable characteristic of the asset, and must be used to arrive at a valuation for said asset. To take a more extreme example, I was looking at some CAD CEFs that have a 25% discount to NAV. However, they also had a management fee of 2.5%. What's the NPV of that management fee? About 25%. In two years, the management fee is still likely to be 2.5% and the discount to NAV is still likely to be 25%.

For the last several years I have been making double digit returns with closed end funds in a fairly low risk manner.

How has your performance compared, precisely, to the the underlying assets in the funds? What percentage of your returns are attributable to improving market conditions that generally narrow NAV discounts?

As the article you referenced discussed, the basic game is to try to "trade around" a fluctuating NAV discount. What source do you use for getting historical NAV discounts? I think the key to this strategy is understanding how discounts to NAV move around for a given fund. I'd be surprised if you have much edge over more sophisticated investors doing this trade, but godspeed if it's working for you. In any event, it's a fairly low risk strategy that might add a little juice to your returns. Just be aware that in a meltdown, you're going to take a bigger hit than comparable indices and open ended funds.

brewer12345

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Re: TIPS or no TIPS?
« Reply #12 on: March 01, 2013, 12:04:50 PM »
I use www.cefconnect.com to view discounts and screen.  At least once a week, I screen all fixed income CEFs and sort from biggest discount down.  I then look for funds with a market cap of $500MM or etter and a discount of at least 10%.  Anything that passes that test is a candidate for due diligence (asset composition, how sanely the portfolio is managed, leverage, expenses, etc.).

Return comes from 3 places: appreciation of the underlying assets, yield and narrowing of the discount.  My favorite plays are when the fund has a fire under it to close the discount.  Sometimes an activist shows up and starts pushing.  Sometimes the managers of the fund take action on their own (buying back shares, etc.).  Sometimes the fund has a charter that requires action if the discount is too big for too long (FOF has such a requirement and requires a shareholder vote on converting to an open end fund).  Sometimes you just have to wait for the market to come back to that specific fund or the asset class as a whole.  It works, though.  Buying at a fat discount is a way to add to your returns over time if everything else looks OK.  At the moment discounts are relatively thin, so WIW is the only fund that passes my tests.

KingCoin

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Re: TIPS or no TIPS?
« Reply #13 on: March 01, 2013, 12:24:53 PM »
Looks like WIW is near the wide end of it's discount range, which makes it somewhat compelling, though there's probably not more than 2-3% juice in it (I guess that's not horrible in the context of TIPS returns).

I'm surprised there isn't more activist activity in some of these funds, especially the ones trading at 25% discounts. Unfortunately, management is much more incentivized to just continue clipping their egregious management fee than to act in the best interest of investors.

brewer12345

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Re: TIPS or no TIPS?
« Reply #14 on: March 01, 2013, 12:57:21 PM »
I think WIW has 7 to 10% juice, possibly more.  Funds that are not trainwrecks (and this one is not) generally eventually trade back to NAV or beyond if you are patient.  GIM is one of the best foreign bond funds out there and a few years ago it traded at a 5 to 10% discount.  Usually around a 5% premium today.

KingCoin

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Re: TIPS or no TIPS?
« Reply #15 on: March 01, 2013, 01:10:51 PM »
I think WIW has 7 to 10% juice, possibly more.  Funds that are not trainwrecks (and this one is not) generally eventually trade back to NAV or beyond if you are patient.  GIM is one of the best foreign bond funds out there and a few years ago it traded at a 5 to 10% discount.  Usually around a 5% premium today.

I wouldn't be so sure. Doesn't look like it's traded closer to within 5% of NAV since briefly after fund inception. It's been stable at 10% for almost a year and a half.

sheepstache

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Re: TIPS or no TIPS?
« Reply #16 on: March 01, 2013, 01:13:33 PM »
I don't have any idea if this is a good idea, but has the OP looked into I-bonds?  You can defer the tax until you sell them.

joer1212

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Re: TIPS or no TIPS?
« Reply #17 on: March 01, 2013, 01:35:56 PM »
I don't have any idea if this is a good idea, but has the OP looked into I-bonds?  You can defer the tax until you sell them.

I use the returns from my taxable account to fund my Roth IRA every year, so I I-bonds are no good for me.

brewer12345

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Re: TIPS or no TIPS?
« Reply #18 on: March 01, 2013, 01:37:06 PM »
I think WIW has 7 to 10% juice, possibly more.  Funds that are not trainwrecks (and this one is not) generally eventually trade back to NAV or beyond if you are patient.  GIM is one of the best foreign bond funds out there and a few years ago it traded at a 5 to 10% discount.  Usually around a 5% premium today.

I wouldn't be so sure. Doesn't look like it's traded closer to within 5% of NAV since briefly after fund inception. It's been stable at 10% for almost a year and a half.

My experience suggests that WIW will eventually trade closer to NAV.  If not, the discount easily makes up for the management fee.  It would at least be hard to lose money on this one, and its pretty likely that I will make money on it.  In a world of limited fixed income opportunities, I will take it.

brewer12345

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Re: TIPS or no TIPS?
« Reply #19 on: March 01, 2013, 01:38:35 PM »
I don't have any idea if this is a good idea, but has the OP looked into I-bonds?  You can defer the tax until you sell them.

You can only put in 10k a year, so its no real panacea.  That said, I have started using I bonds as part of my emergency fund.  Better yields than savings accounts and most CDs, no risk, and tax deferral: what's not to like?

Chris

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Re: TIPS or no TIPS?
« Reply #20 on: March 01, 2013, 09:12:27 PM »
You can only put in 10k a year, so its no real panacea. 

Actually it's even better, 15k, by using a tax refund.

Two big benefits that I bonds have over TIPS

  • The rate will never be < 0
  • The interest is tax deferred until redemption. If you can hold until you're FI, you'll pay the federal tax at a lower rate

Undecided

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Re: TIPS or no TIPS?
« Reply #21 on: November 19, 2013, 05:03:42 PM »
I think WIW has 7 to 10% juice, possibly more.  Funds that are not trainwrecks (and this one is not) generally eventually trade back to NAV or beyond if you are patient.  GIM is one of the best foreign bond funds out there and a few years ago it traded at a 5 to 10% discount.  Usually around a 5% premium today.

I wouldn't be so sure. Doesn't look like it's traded closer to within 5% of NAV since briefly after fund inception. It's been stable at 10% for almost a year and a half.

My experience suggests that WIW will eventually trade closer to NAV.  If not, the discount easily makes up for the management fee.  It would at least be hard to lose money on this one, and its pretty likely that I will make money on it.  In a world of limited fixed income opportunities, I will take it.

I wouldn't normally dredge an old thread, but in doing some thinking about closed-end opportunities for fixed income, I thought to see if there was any useful discussion over here. This was the first thread I found, and I idly checked the price of WIW .... Curious as to whether you've modified your strategy or changed your expectations.

brewer12345

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Re: TIPS or no TIPS?
« Reply #22 on: November 19, 2013, 05:39:22 PM »
Still own WIW.  I want to own some tips and this is a cheap way to do so.

KingCoin

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Re: TIPS or no TIPS?
« Reply #23 on: November 19, 2013, 10:22:49 PM »
I wouldn't normally dredge an old thread, but in doing some thinking about closed-end opportunities for fixed income, I thought to see if there was any useful discussion over here. This was the first thread I found, and I idly checked the price of WIW .... Curious as to whether you've modified your strategy or changed your expectations.

You looking for inflation protected funds or CEFs more broadly? I think there's a lot of opportunity there, especially in funds that are trading 10% or more cheap to their 5yr average NAV discounts. I think rates still have some normalizing left to do, but the risk/return is much more interesting than it was 6 months ago.

Couple good tools for screening opportunities:
http://www.cefconnect.com/Screener/FundScreener.aspx
http://screen.morningstar.com/cef-quick-rank/

Major things to look out for:
- Bond type, duration and quality
- Current yield
- Discount to NAV
- How current discount to NAV compares to historical average discount to NAV
- Management Fees
- Leverage
All of the above are fairly critical and differ widely from fund to fund.

KingCoin

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Re: TIPS or no TIPS?
« Reply #24 on: November 22, 2013, 11:01:25 AM »
If you're worried about rates, you might want to look at GHY. Duration is only about 2.6yrs so it's not very sensitive to a rates increase. Juicy yield at ~9%. Discount to NAV is the biggest it's ever been at ~11% (pretty crazy for a low duration fund during a stable market). Expense ratio is high, but not out of control, at 1.4%. It's a high yield fund that uses some leverage, so it's not a super low risk proposition.

I think SGL looks attractive if you don't mind the extra duration and NPI and NMO look interesting in the muni space.

Undecided

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Re: TIPS or no TIPS?
« Reply #25 on: November 22, 2013, 05:44:55 PM »
I wouldn't normally dredge an old thread, but in doing some thinking about closed-end opportunities for fixed income, I thought to see if there was any useful discussion over here. This was the first thread I found, and I idly checked the price of WIW .... Curious as to whether you've modified your strategy or changed your expectations.

You looking for inflation protected funds or CEFs more broadly? I think there's a lot of opportunity there, especially in funds that are trading 10% or more cheap to their 5yr average NAV discounts. I think rates still have some normalizing left to do, but the risk/return is much more interesting than it was 6 months ago.

Thanks for that. I'm looking at CEFs generally, not particularly interested in inflation hedged funds. I've been distracted in my search, so thanks for the prompt to resume it.

brewer12345

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Re: TIPS or no TIPS?
« Reply #26 on: November 23, 2013, 08:37:13 AM »
My favorite vehicle for non-USD bond exposure has widened out to a fat discount to NAV: GIM.  No guarantee that the discount won't get bigger, but a high single digit one is attractive to me.  Note that this fund usually pays out cap gains at the end of the year, so this is probably not a time you would want to buy this fund in a taxable account (wait until January).

kyleaaa

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Re: TIPS or no TIPS?
« Reply #27 on: November 24, 2013, 08:18:20 AM »
With a portfolio that small? I'd go without TIPS. When you get close to retirement I'd rethink things.