By David Enna, Tipswatch.com
I recently got an email with a question from long-time site reader Jay, who included a meme to illustrate his point. Here it is:
A TIPS Conundrum:
Lately I’ve been struggling with what to do in my bond portfolio. Should I take advantage of current high real TIPS yields to lock in high returns with LT TIPS? However, doing so goes against my long held desire to avoid taking interest rate risk on long duration bonds, especially with rates jumping around.
Which to do? Locking in high real TIPS yields for 10-20 years might be a unique opportunity. OTOH, buying LT bonds of any kind in a volatile market is very risky.
I don’t know the answer, but I came up with this Meme to describe it.
My thoughts
I understand. I also have been looking to load up on longer-term Treasury Inflation-Protected Securities (with maturities beyond 10 years). I see the logic in locking in attractive real yields for a longer term. But that’s a difficult task for four reasons:
- I am nearing age 70 so my hold-to-maturity range is optimistically no more than 21 years, stretching out to potentially 2044.
- There is a yawning gap in TIPS available on the secondary market, with no TIPS maturing in the years 2034 to 2039.
- TIPS maturing in years 2040 and 2041 have a combination of a high coupon rate and a high inflation index, making them pricey investments versus par value.
- TIPS maturing in years 2042 to 2045 have lower coupon rates and therefore sell at a discount to par, but also have inflation factors of 28% or higher. These are more attractive, but still pricey versus par value.
Why the gap?
20-year TIPS. From July 2004 to January 2009, the Treasury issued 20-year TIPS, resulting in just five securities of that term. Then Treasury discontinued the 20-year TIPS and it has never returned. That means there are no 20-year TIPS maturing beyond the year 2029.
30-year TIPS. The Treasury offered 30-year TIPS from 1998 to 2001, and then discontinued this maturity until it was restarted in 2010. So that means there are no 30-year TIPS maturing from April 2032 to February 2040.
So we have a gap, with no TIPS available to purchase with maturities from 2034 to 2039. In a real-life portfolio, what does this mean? Here is my TIPS ladder, updated through May 2023, with all par values set to $1,000 to present as an example:
The key here is that I have no TIPS maturing in the years 2034 to 2040. There are no TIPS available for years 2034 to 2039, and I don’t find the TIPS available in years 2040 and 2042 attractive enough to purchase.
In the last year, I’ve developed a habit of looking at the secondary market for TIPS maturing in my gap years. That worked out well for me in November 2022, when I grabbed CUSIP 912810RA8 — maturing in February 2043 — with a real yield to maturity of 2.02% and a total investment price below par value.
That was a lucky hit, just as TIPS real yields were peaking. I haven’t been able to find anything nearly as attractive in recent months. Here is a look at secondary market prices as of Wednesday for my gap-year TIPS:
The first two on this list, which work “better” in my life-expectancy timeline, both have higher-than-market coupon rates and high inflation factors, making their pricing at least 7.5% above purchased principal. I don’t like buying above-par principal at prices well above value. So these are out.
The last four in the list would work better for me, with coupon rates below market real yields and therefore selling at a discount. Note that CUSIP 912810RA8 — which I bought last November — now carries a real yield to maturity of about 1.7%, down from 2.02% at the time of my purchase. Plus its inflation index has now increased about 1.8%.
Of these issues, I’d be most interested in CUSIP 912810QV3, which matures in February 2042 and would fill that spot on my TIPS ladder. I’d just like to see the real yield rise a bit higher.
• May 28 follow-up: I pulled the trigger on the February 2042 TIPS
My personal opinion, and you can disagree: I am OK with buying inflation-accrued principal (meaning above par value) if I can get it at a discount price. That is true for all four of the the TIPS maturing from 2042 to 2045.
When you pay a price above par value for a TIPS — which is often the case on the secondary market — you take a tiny risk because the amount above par is not guaranteed to be returned at maturity if we hit a long stretch of deflation. That is a risk I am willing to take.
What about a TIPS fund?
Another option for investors would be to look at an ETF that invests in longer-term TIPS. One option is the PIMCO 15+ Year US TIPS Index ETF (LTPZ), with an expense ratio of 0.2%. Because of its long duration (19.8 years) this fund is volatile. If real yields rise in the future, its performance would be disastrous. If they fall, it will do very well. Here are its total annual returns, from Morningstar:
This fund’s total annual return over the last five years is 1.43% and for 10 years, 1.33%. Because of its volatility, LTPZ doesn’t fit my investment style or meet my need for stability in a TIPS investment ladder. My vote is “no.”
The only TIPS fund I currently own is Vanguard’s Short-Term Inflation-Protected ETF (VTIP) with an expense ratio of 0.04% and a duration of only 2.6 years. I use this fund in a traditional IRA to hold money awaiting investment in individual TIPS. It’s not very volatile and also not very exciting, which fits my needs:
VTIP’s total annual return over the last five years was 2.81% and for 10 years, 1.53%. Both of these returns beat LTPZ’s performance, with much less risk. But while I like VTIP, it doesn’t fill my need for more exposure to longer-term TIPS.
I Bonds can fill the gap
If you purchase an I Bond today with a fixed rate of 0.9%, you get a flexible investment that you can hold for any time period, from 1 to 30 years. So I Bonds can work well to fill that TIPS gap for the years 2034 to 2039, and beyond. I Bonds don’t sell at a premium and can never lose a cent of value, even if deflation sets in or interest rates rise. For that reason, I think I Bonds are much more attractive than a long-term TIPS fund like LTPZ.
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• Upcoming schedule of TIPS auctions
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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear. Please stay on topic and avoid political tirades.
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
I have 20k in BND, -2.2 since 2014. Would it be wise to transfer it to short-term t-bills, or leave it where it is?
I am not a financial adviser, so just some thoughts: BND since 2013 has had a total annual return of 1.35%, so your -2.2% number probably wasn’t including the dividends you have received. But last year was rough, with the fund falling 13.1%. It is up 2.22% in total return year to date. (Schwab estimates $10,000 invested in BND in 2013 would be worth $11,448 today.) I own BND as a core fixed-income holding, a long-term investment. I also love T-bills right now for short-term cash needs. So it might depend on how long you plan to hold this investment.
I have been an uneasy LTPZ investor, and while I underestimated the fund’s volatility, I also understand why it happened. My main rationale for desiring longer maturities is I assume the government will stop issuing TIPS at some point to help limit interest expenses.
I took particular interest in the Morningstar “Total Return” breakdown you provided , but had two related questions:
1) Did you calculate the “fund’s total annual return over the last…10 years, 1.33%”? I didn’t see it on the Morningstar site and also couldn’t replicate it with that table (I got 0.73%, but am not confident with my calculation – I think I am missing something).
2) Perhaps “Total Return” includes the interest payments made along the way? If so, how did you figure that into your calculation?
Yes, total annual return reflects both the change in net asset value + dividends paid out. On Morningstar, navigate to the “performance” tab and you will find trailing total returns. Right now for LTPZ that number is 1.65% over the last 10 years.
Got it – many thanks!
Dave – I am confused about why you dislike bonds trading at a premium so much, especially when that premium is due to high accretion. If I want to buy $15,000 of TIPS and the one I want is par, then I buy $15,000 face. If it’s trading at a full accreted price of 150, then I buy $10,000 face. Either way, I have $15,000 of TIPS, and (ignoring real yield changes) if prices rise 10% I will then have $16,500 in TIPS.
Price relates YTM to coupon rate, and the inflation index relates the current price level to the historic price level. In neither case should you care (other than because of the deflation floor)! Buying a bond is wholly about today, and forward-looking. History doesn’t matter. (Okay, there are tax implications if you have to amortize an OID etc but theoretically and purely, it shouldn’t matter.) right?
Totally correct. My problem isn’t with high accruals, but a combo of high accruals and a higher-than-market coupon. That hits a nerve, but I admit it’s somewhat illogical. So I tend to look for less lopsided options.
Hi Mike – another consideration for some of us is called reinvestment risk. If you purchase a TIPS with a coupon that is higher than its real yield, then each coupon payment will include all of your real yield plus some return of capital. If you have this TIPS in a taxable account and are using the coupon payments for current expenses, then that’s fine. No problem. If instead you have the TIPS in a tax-deferred account for future spending, then that coupon payment has to be reinvested with the risk of rates being less favorable than what you are getting on the TIPS. So in a tax-deferred account, a risk manager would prefer the lower coupon so as much of the real yield as possible is delivered at maturity when needed.
Good point. Thanks.
Well, then it’s even more confusing. Higher coupons lowers the duration, which means less interest rate risk. So if you want today’s yields for a long time with less interest rate risk, you should PREFER high coupon bonds to, say, a TIPS STRIPS (zero coupon, no reinvestment risk, but the longest possible duration). You can’t have high yields, low risk, with low coupon payments – you have to pick two! (Unless you use iBonds, which have the same risk but just don’t mark it to market so it looks like it has no risk).
Duration (Macaulay) is the present-value-weighted-average time periods to maturity. The interest rate risk results from the change in the present value of the real principal and the change in the present value of the real coupons, weighted by their present values. So more weight in payments that occur sooner (higher coupons) lower the overall risk because more of the value ‘lives’ in the coupons.
I certainly understand why someone would want less reinvestment risk. But then they’re gonna get interest rate risk. They’re opposite sides of the same coin!
Hi Mike – sorry for the confusion. Reinvestment risk is the risk that the interest and principal you receive may have to be reinvested at a lower rate. Interest rate risk (duration) is a measure of how much the price of a bond may increase or decrease as a result of an increase or decrease in market rates. Duration only applies if you don’t hold your bond until its due date (Richelson). So for that cohort of investors who hold their individual bonds to maturity, the interest rate risk is moot. When the bond principal is returned at maturity, the investor may have reinvestment risk if the cash flow is not being used for a specific purpose and some may casually describe this as “interest rate risk” since interest rates may have changed, but, as you note, among bond investors the term interest rate risk has the specific meaning above and is measured as duration.
We live in a strange time where you can have bonds with high yields, low risk, and low coupons all at once if you desire. The secondary Treasury market is full of them right now.
In the shorter maturities, the TIPS market has multiple choices within the same year of maturity. Having choices often means trade-offs and each investor can select the trade-offs that are best for their situation.
The Safety-First approach to retirement income is quite different from the Total Return mindset. Interest rate risk is a hot topic in the Total Return world due to the “failure” of TIPS (and other bond) funds, but not so much to Safety-Firsters who buy individual bonds, hold them to maturity, and apply their cash flows to the liabilities to which they were matched.
Mike and T Lee … the overriding premise of this site is that TIPS will be purchased and held to maturity. (If you can’t do that, you are a TIPS trader, not my style.) For that reason, it doesn’t make any sense to buy a 20- to 30-year TIPS in a taxable account with a low coupon rate, which won’t cover current income taxes for 20+ years until maturity. And it probably is a little more desirable (but still not wonderful) to pay a large premium price for both additional principal and a higher coupon rate in a taxable account. So … let’s rule out the taxable account purchases of long-term TIPS at a premium.
In a tax-deferred account, though, I accept Mike’s premise that real yield is the most important factor, even if you are paying a premium. I have evolved! I knew this to be true, but I had an itchy feeling about it. But the premise is still that these investments are held to maturity.
Now, I await Mike’s correcting message, which is needed at all times. He is the super-expert.
Ha ha – so nice of you Dave!
As someone who teaches about TIPS, and bond math, etc, my arguments may seem as mostly nuance. But they’re important. Actually, holding to maturity is not the riskless point. When you buy a bond with a 20-year maturity and, say, a 12-year duration, your zero-risk part is actually 12 years. That’s the point where the reinvestment risk balances out the price risk (lower rates going forward being generally good for the price of the bond, and bad for reinvestment risk). We always demonstrate this in bond math classes. (Of course, it assumes parallel yield curve shifts etc but anyway that’s the reason duration is important). If you have a need for cash in 12 years, you shouldn’t buy a 12-year bond – unless it’s a zero – but any bond with a 12-year duration!
However, that’s mostly a nuance that it’s important for risk managers and derivatives traders to understand – not individual investors! That said, understanding that higher coupons means lower duration – more reinvestment risk but less price risk – is especially important in TIPS where your realized coupons as a percentage of the principal are lower than with a nominal bond (since the ‘inflation compensation’ part of the coupon is rolled into the principal rather than being paid out with it, as in a normal bond). So TIPS tend to have (real) durations much closer to their maturities than nominal bonds.
All that being said, theory tends to ignore tax consequences and trust circumstances such as when proceeds are split between income beneficiaries and remaindermen. Which is why people don’t invite tax professionals, estate lawyers, OR inflation quants to cocktail parties!
This article was very helpful. Thank you. It confirmed my suspicion (after scouring the secondary TIPS market) that there currently are not any “great” options maturing more than ten years out. For now, i’m piling into CUSIP 91282CGK1 (maturing 2033), which (as of yesterday 5/26) could be purchased through my brokerage (Schwab) for no commission, in amounts as little as $1,000, at real YTM 1.55%. (The out-the-door price is still less than par.) And i’ll just have to watch all the upcoming 10-year auctions and roll into those (if yields remain reasonably attractive). Also glad i grabbed a bunch of 5-year CDs in March at 5.0% – 5.05%… they’re now going for 4.5% at best through my brokerage… I’m buying CUSIP 91282CGK1 unless/until the 5-year CDs come back up to at least 5%, betting on “sticky” inflation for at least the next couple years.
Thanks Tom. I am posting a follow-up article tomorrow on a TIPS purchase I made this week, maturing in 2042. Like you said, not “great,” but it met my goals.
I want to make sure I understand this comment “I don’t like buying above-par principal at prices well above value. So these are out.”
Isn’t the price arguably secondary to whatever the current Ask Yield to Maturity Yield is? The price could still be above 100, but if the Ask Yield to Maturity was higher than another bond trading at a lower price, that could be a better call for some people, correct?
I know there is nuance in that the price generally is going to be higher on a large coupon bond that’s fairly old already, and some ancillary issues like deflation protection, etc., but I wanted to make sure I’m not missing something when I generally use the Ask Yield to Maturity for determining almost 95% of my secondary market buying decisions.
Sure, the real yield to maturity is the most important factor. As I said, I am OK with buying “unprotected” principal over par but I’d rather not pay a premium price for that extra principal. All of those TIPS maturing from 2040 to 2045 have accrued inflation of 28% or more, but only two are selling at a 7.5%+ cost premium. With the others, you get the additional principal at a discount. It all evens out because of the coupon rate; so this is admittedly a “personal quirk” of mine.
Thank you David for the conclusion: IBonds over long-term TIPS funds. In complete agreement. My mistake with I Bond purchases was waiting/missing the 3%+ fixed rates, but congratulations to you for locking in those rates back in 1998-2001.
Waiting until October for 2023 IBond purchases. The TBill and TNote rates highest in ~15 years so buying these as well as BND that has declined ~10% since Jan 1 2022.
Do you have any other fixed income ideas outside of TIPS/IBonds?
Just the usual: I continue to roll over sets of 13-week and 26-week T-bills, a strategy I have been using for over a year. And since the banking crisis erupted, I’ve been watching for attractive 2- and 5-year brokered CDs. BND remains my core bond fund holding.
VTIP doesn’t seem to have performed well as inflation protection: as you say “VTIP’s total annual return over the last five years was 2.81”. This seems to be well below inflation for the last five years. I don’t understand why the performance has been so poor given that it holds short term securities, which should not be sensitive to rising long-term rates.
I enjoy the blog! Thanks!
As with any bond fund, the underlying assets of VTIP decline when real yields rise. At the end of May 2022 the 5-year real yield was -1.78%. Today it is 1.78%. That’s an increase of 356 basis points, or 3.5 times the VTIP’s duration of 2.6. So the expected decline would be about 9% over two years, but actually VTIP is down about 1.1% over that time. Inflation adjustments greatly lessened the hit from higher real yields.
Thank you! I didn’t appreciate how much real yields had changed.
I like the idea of buying a Tips fund like LTPZ due to lack of secondary options. However, an issue I have is suppose I buy a bond fund on the long end of the curve ( For ex, I currently own TLT). As I get older, I want the maturity length of the bonds to decrease, not stay the same. In 20 years, I don’t still want 20 year bonds. It’s too bad there isn’t some sort of target date bond fund that adjusts over time.
There is a 5-year target duration TIPS fund, TDTF, but I have to admit I don’t understand how it works. https://www.flexshares.com/us/en/individual/funds/tdtf
Jay, there is no interest rate risk on an individual TIPS held to maturity. Any maturity. The real interest rate is known at purchase and will be what you will have received at the maturity date. By purchasing an individual TIPS and holding it to maturity you remove the interest rate risk.
Interest rate risk only affects those who sell individual bonds prior to maturity or own funds.
Jay, if you’re an asset allocator who rebalances, you do have to decide what to do about the market price volatility of your individual long-term TIPS at rebalancing time. That volatility is irrelevant to you from an interest rate standpoint, but it could affect a rebalancing calculation. You don’t ever want to sell your individual long term bonds so you’ll have a small position in a bond fund or in individual TBills for rebalancing purposes. To decrease the volatility, cross out the market price of each individual TIPS on your monthly statement and write in the inflation-adjusted principal instead. Most months this will be a small upward adjustment and will keep the market price volatility (which doesn’t really matter to you if you’re holding to maturity) of your long-term TIPS from introducing excess volatility to your rebalancing actions.
These are good points. In my case, about half of my traditional IRA is set aside in BND, the total bond market. In future years, that will be the source of required minimum distributions and charitable donations, so I will be able to allow all individual TIPS to mature. (RMDs, though, will be based on the TIPS’ market value. There’s no way around that.)
T Lee, I appreciate your comment, but we disagree as to what constitutes “interest rate risk.” I agree in principle that TIPS bought as a ladder and used for specific future expenses can be considered to have limited interest rate risk. However, they are still very much subject to price fluctuations depending on prevailing rates.
These price fluctuations can be extremely risky for any investor who encounters an unexpected need for liquidity – which could happen to any one of us.
I don’t think it’s a good practice to “cross out the market price of each individual TIPS on your monthly statement and write in the inflation-adjusted principal instead.” If your TIPS are underwater, it means that they are yielding below the current prevailing rates and can only be sold at a discount. That’s a significant risk in my book, and simply pretending they are still worth what you paid for them won’t make that go away. That’s exactly the kind of accounting that got Silicon Valley Bank into trouble.
Again, I understand where you’re coming from and appreciate your suggestions. We simply disagree on the nature of the risks involved.
Yes, you and SVB have interest rate risk if you don’t have adequate reserves for contingencies to hold the bonds to maturity. Your interest rate at purchase is not “locked in” if you sell ahead of time. I agree completely with you on the nature of the risks involved.
What are the positives and negatives of holding Vanguard Sh0rt-Term Infl-Prot Sec Idx Adm (VTAPX) instead of VTIP? (I am too old school I guess, and have not made the leap into the world of ETFs.)
The expense ratio is slightly higher at 0.06% but these are essentially the same funds.
One issue, taxes, if we hold long term TIPS outside a tax sheltered structure. Yes I am happy I invested in maturities greater than 10 years but distressed when I calculated my taxes for last year.
Age 91 seems a trifle pessimistic these days for an estimated life expectancy. Seems that 95 is the commonly accepted figure. In this area decent assisted living facilities are charging $ 4000 per month currently.
On living past 91 … I hope so. I expect my wife will easily get there. All my TIPS purchases in the last year+ (when real yields suddenly got interesting) have been in a traditional IRA and all of that money will eventually be taxable.
I am a few years younger than you but have considered the same issues. I don’t like TIPs funds as they failed miserably when rates increased. I’ve bought 5 and 10 year at auction. 30 year is too far out. I have a lot of IBonds that are maturing 2030-2032. I bought a few Ibonds last year and will buy some more this year. The tax impacts will be problematic on the Ibond maturities. Good discussion.
Having I Bonds purchased from 2000 to 2002 is “a very good thing.” All have very good fixed rates. I try to set an income goal for each year and plan to get close to it, through Roth conversions, withdrawals, etc., and in those future years I’ll have to account for maturing I Bonds as well. This works for me but it’s important to plan for the future taxes and Medicare IRMAA surcharges.
I love I Bonds, but to the best of my knowledge, you cannot buy them in an IRA, correct? It’s the lucky retiree who has enough cash outside their retirement accounts to be able to fund I Bonds to the maximum each year. Of course, one could withdraw from their IRA to have the cash to buy I Bonds, but that would be cash above and beyond the RMD, meaning a bigger tax hit. The bigger tax hit could limit the amount of Roth conversions I’d be willing to do.
It’s true. The issue of funding I Bond purchases after retirement is real. I happen to have a collection of taxable TIPS held at TreasuryDirect, going out to 2029. When those mature there is almost no tax hit and I use the proceeds to buy I Bonds. Now all my TIPS purchases are made in a tax-deferred account, however.
David,
Do you prioritize I Bond purchases over TIPS? I do, one reason being since the annual limit is relatively low.
Rob, my general rule is to always buy I Bonds, up to the limit, each year. My rule with TIPS is buy, buy, buy when real yields are attractive. So I have been focusing more energy toward TIPS this year, since there is no limit on purchases.
What about shorter-term TIPS funds, like Vanguard’s Short-Term Inflation-Protected Securities ETF (VTIP), which includes TIPS with less than 5 years until maturity?
Good question. I own VTIP and I like it. I added a section to the article about that fund.