I have a question regarding a fairly safe investment for funds which I will need within the next 3-5 years. I started saving for a remodel project about 6 months ago with $5k initially, and now plan to add about $500 per month. My goal is to preserve the principal, but earn enough return to guard against inflation.Initially, I opened a Vanguard account with the beginning invested in VIPSX (Vanguard inflation-protected securities). I anticipated the account may yield between 2-3%, but to my surprise it's yielded around 8-10% (haven't figure exactly because the account actually started at $8k, then I withdrew $3k 3 mos. later, now its worth about $5.4.) My plan was to keep adding the $500 or so per month into that account. However, I've been hearing about this "treasury bubble" and now wonder if I should be diversifying in bonds a bit. I read through the FAQs on this board - they were GREAT! Thank you so much "Loki?" for posting them. From all that reading, it seems as though I am relatively safe from catastrophe investing in bond funds - as yields go up, the NAV goes down, BUT yield and NAV seem will probably compensate enough to at least preserve principal. I am sure this is over-simplifying, but I don't want to do Master's-level research on this sum of money.OK, my questions (thanks for reading if you are this far):1) Would it make sense to use VIPSX and VFSTX (short-term bond fund) to adequately protect principal and protect against interst for the short-term (3-5 years)?2) Is there a better plan? I looked at CD rates, but ~1% yields don't guard against inflation IMHO. 3) Is it possible that there is a bubble in bonds that would cause my principal to deteriorate, specifically I worry about that when my supposedly safe and boring investment into VIPSX has yielded 2-3 times what I would expect for a slightly riskier savings accounts. Any thoughts, questions, or suggested links for more info would be greatly appreciated.Sincerely,John (cheezyches)
Whoops - "edit before posting!" (Trying to rush out to dinner with another family, "let's go!" says sweetie, "Dad - I'm thirsty" says boy, "Just a minute..." I mumble too many times). Question #1 should read "...protect against inflation for the...", not "protect against interst for the..."Many apologies for lousy grammar. The teacher in me is ashamed.cheezy
Here is my quick and dirty two cents...<BUT yield and NAV seem will probably compensate enough to at least preserve principal>....I did not look at the fund prospectus, but if interest rates rise after purchase, I believe most times NAV will decrease more than you'll recieve in dividends.<Is there a better plan?>.... It sounds like you want access to 100% of the funds in 3 to 5 years. I'll suggest two alternatives. One is open an account with Etrade or Zionsdirect and purchaser zero-coupon treasuries (STRIPS) due in 3 to 5 years. If your putting in $500 per month, you'd just purchase every other month. The $10.00 commissions will take a little bite, but without breaking out a calculator, you might come out ahead than if it was in a short term bond fund Secondly, buy a note ever other month in treasury direct, two year or five year. I added on 800 square feet to our ranch type house, adding in an upstairs, a bathroom, wood flooring, tile flooring, etc, was sort of fun. If you've got questions there, feel free to ask.
Cheezywelcome.I'm not a fan of most band funds for extended holding periods. The way they tend to work is that while interest rates are falling you gain in principal, which is great. The problem is when interest rates are rising, the math works against us the increased interest rate doesn't adequately cover the loss in principal. To me this means I need to work these funds not just fire and forget and assume they are safe. If I'm investing in a bond fund I'm guessing/betting that rates will decline. At some point I'll have to exit and preserve my capital gains. You are in no way bound to agree with my assumptions. I would encourage you to take a good look yourself. Part of our FAQ deals with bonds v bond funds. A bond fund is not a bond equivalent, many sellers of bond funds suggest that they are but the math just doesn't work in our favor. In the end a bond fund or any fund makes money on having many people investing large sums in the fund and charging their management fees. What a bond fund is a company that takes your capital and invests it for you in bonds; they buy bonds, the bonds either mature or are sold, the company rinses and repeats. Their is no maturity date the fund goes on and on unless it becomes defunct for lack of capital. The result is NAV, the value of your principal, goes up and down as interest rates change.A bond has a maturity date and as such a known steady value. If I buy a bond for $1,000 I know that I will get my interest (dividend coupons) on their schedule and I'll get my $1,000 back at maturity. During my holding period the market value may go up or may go down but, assuming they do not default, I will get my $1,000 back on the maturity date. Do you see the difference? Its important. With a 3 - 5 year spending horizon capital preservation is far more important than capital appreciation. Or written another way you are probably better off living with 1% interest rate while avoiding a 5% - 10% ding to principal. Still another, chasing a 5% yield that might end up with a 10% hit before or right when you need the money is probably not the best choice. That doesn't mean you have to live with the lowest rates. What it means is that anything you shop for with better rates still needs to have adequate principal protection built in or priced in. What are your options:A)passbook accounts - FDIC insured piddly interest rateB)CD's better rates but the money is locked in for a fixed period. They can be shopped for so you can find better ones then your local bank my offerD)Short or Ultra short funds; principal is at minor risk and you may or may not outpace a carefully selected basket of CDs. They are flexible and easy to add to or withdraw from. (I suspect longer term funds may be at more risk than you would want to accept, I may be wrong)E)Treasury products that mature between now and when you need the money. They are bought in $1,000 units so you wouldn't be able to add $500 a month. They may actually cast you a little more than $1,000 if they sold at auction above par. Or you can by them on the secondary market and maybe shop more carefully. F)Very well researched high on the scale corporate bonds. They may pay a bit more than treasuries. For the higher return you are accepting the potential of default which needs to measured and understood before buying. Does that help or did I just confuse things?jack
Hi Cheezy, Welcome! What I have been doing is investing in a 'balanced fund'. This is a fund that is both stocks and bonds. In particular Hussman's Total Return Fund (HSTRX), It is mostly Treas., and TIPS, with currently 2% foreign currencies, 2% PM's(precious metals), and 4% utilities. These vary as his thinking changes. To get around the problems Jack mentioned, Hussman uses hedging (puts and calls) on the interest rates to defend against rates going the wrong direction. He is a wizard at this and I'm not, so I have him do it for me. A very conservative fund, BTW. His wonderful weekly letter and a prospectus for this fund can be found at www.hussmanfunds.com rk (long HSTRX)
I just took a look at this fund, HSTRX, that you mentioned. It seems to have an awfully high expense ratio compared to some of the Vanguard funds, for example. Comments?
Thanks for the advice, esp. Jack and Blacktreechaser.I have some reflections and a question:Reflection: I had not thought about the timing of interest rate jumps, and therefore potential loss of NAV on a bond fund. I was only looking at the upcoming 3-5 year period with gradual changes to interest rates. It makes sense to be leery of bond funds as I could reap low yields until just before needing the money, interest rates could rise, and I could take a significant hit to principal. That is not a risk I am willing to take with this money.Question: So why might the performance of the fund that I do own, VIPSX (Vanguard Inflation-Protected Securities) which invests in inflation-protected treasuries, be so strong? I mean, the NAV has appreciated by roughly 8-10% over the last 6 months while interest rates have stayed pretty flat (I think). Is this just supply and demand? I read somewhere on this board that Chinese gov't may be pouring money into TIPS. If so, how does one understand the underlying value of the fund? End result: I have some research to do for the other options. So far, I can't find CDs that will earn much more than 1%, same with my savings account. I'll still look into treasuries and individual bonds (although I am not familiar with how to evaluate). I may need to be satisfied with lower yields. I'll probably be most interested in US treasuries I-bonds to protect against inflation.cheezy
Hi Bleary, I just took a look at this fund, HSTRX, that you mentioned. It seems to have an awfully high expense ratio compared to some of the Vanguard funds, for example. Comments? 0.67% is towards the bottom end for this kind of fund. I don't know which Vanguard to compare it to. VIPSX is a simple TIPS ladder(which I like also!), but it isn't hedged of managed anything like HSTRX...rk
The folks at Vanguard are customer-friendly. You can always call them up and talk to them and ask them what caused the nice performance. They are helpful on the phone. It also depends on when you bought it, what fund holdings happened to mature at that time, etc, etc, demand for TIPS at the time. The quarterly or semi-annual report will likely have some explanation if it was an abormality. Compare that 6-month period of good returns to their 5=year return rate, see if its just an abnormaility.
I think it would be beneficial to move away from an overly general answer to the difference between bonds and bond funds. I believe it fails to address a major point. Quoting the FAQ: "The general expectation is that TIPS are less subject to interest rate risk than Treasuries of the same maturity, although there is no guarantee."Concern over a drop in NAV due to the effectively infinite maturity of bond funds doesn't hold as much significance in a TIPS fund. It is not zero, but it is less significant. If you invest in anything that is not principal protected (such as an FDIC insured CD), you risk principal. This will be a difference between a bond and a bond fund, and one you cannot escape (the issue really is about the magnitude)When you are investing in a traditional treasury, you are bearing interest rate risk in two forms. The major form depends on the *perception* of future inflation. If the perception changes such that higher inflation is expected, rates will rise. On a simple instrument like a zero-coupon bond, that means the price of that bond will drop (significantly for longer term bonds).When you are investing in a TIPS, there is no perception risk. TIPS are not subject to a change in perception of future inflation, because their principal adjusts to real inflation (as measured by the CPI-U). There is a risk that the CPI-U is not accurate to your situation (it is for me, YMMV).Both types of bonds also have another form of interest rate risk, and that is the required rate of real return. In a TIPS, this is the coupon, and if the required rate changes, then the value of a TIPS will also change in order to preserve that required rate for the buyer. As a magnitude, this interest rate risk tends to be a lot smaller than changes from the perception of future inflation.TIPS are also subject to a form of "distortion" that is not present in normal bonds. TIPS are always guaranteed to pay out their face value at maturity. However, inflation or deflation may occur in the interim. In the case of inflation, the TIPS principal will increase, and the TIPS will continue to behave as a TIPS. However, in the case of deflation where the principal value drops below par, I would note that a TIPS will start to behave differently... because there is always a lower bound on the value (as the TIPS will eventually start to act as a traditional treasury bond because the CPI-U principal correction will become irrelevant to the value of the TIPS)This "distortion" was part of what was acting up late last year into early this year. Since some TIPS had appreciated while other TIPS were new, the pricing of TIPS started to become inconsistent. Older TIPS deflated from their appreciated principal values, but stayed above par. Newer TIPS dipped below par, and their pricing started to be distorted by the "lower bound" value. Newer TIPS become much more popular (since they were perceived to be much less risky). The older TIPS dropped more in value. I think Wendy even managed to take advantage of this to her benefit.As far as your Vanguard fund, remember that mutual funds mark their bonds to market every day. This means those distortions will show up in the NAV of the fund. The fund held more of the older TIPS, thus had more of an impact to their NAV (you can see this in the chart of the fund). Since it held more of the older TIPS, those dropped more significantly in value than the index or other funds, but when the concern over deflation reversed in 2010, the value of TIPS returned more to "normal", and the Vanguard fund's NAV returned more to what it was before the crisis. This return to "normal" is what you captured as your total return that you find "outsized". Tom
cheezy,I may need to be satisfied with lower yieldsI think this is your best starting position. As you said in you first post your stated goal is to "save" which is a different goal than capital appreciation. If we go here http://cdrates.bankaholic.com/?product=18&sort=2&go_...and play around with maturities you might find some other options. With the FDIC shutting folks down it might be a good idea to do a little research on any bank offering above average rates. Looking here(scroll down to the fixed rate chart) http://www.treasurydirect.gov/indiv/research/indepth/ibonds/...and you will find that current fixed rate isn't very favorable for an instrument designed to be held 5 or more years. If you redeem I Bonds before they’re five years old, you'll forfeit the three most recent months’ interest; at or after 5-years old, you won’t be penalized.Quick peak at Treasury rates and we see 3yr @ 1.46 and 5yr @ 2.47; zeros have a few basis bump above those. all of the above is intended to get your feet wet so you can do your own research.jack
<The general expectation is that TIPS are less subject to interest rate risk than Treasuries of the same maturity, although there is no guarantee> I disagree with this, or at least put the emphasis on NO GRARANTEE, especially for the projected term (3 to 5 years). Rates of inflation and interest rates on treasuries do not walk arm in arm. P.S. If anyone knew the absolute outcome of any, they would only have to know it once. For all I know, the TIPS fund just might blow out everything else in the next 3 to 5 years. But my best reccommendation now is to stick with direct ownership of a bond, zero or coupon. If you're 100% set on remodeling, and your local suppliers might be hurting right now, maybe think about "investing" in the light fixtures, wiring, etc? (depending on how big a project you're taking on).
I disagree with this, or at least put the emphasis on NO GRARANTEE, especially for the projected term (3 to 5 years).I thought my second paragraph did a decent job of honing that point.Rates of inflation and interest rates on treasuries do not walk arm in arm.Of course not, but he's not investing for maximum return, he's saving in a way to try to protect himself against inflation for a specific project. By investing in traditional bonds (Strips, zeros, whatever), he bears the risk of being incorrect based on today's perceived inflation vs. what really happens. Swapping to TIPS trades that risk to the government in exchange for any error in the CPI-U vs. inflation in his specific segment (home upgrade). Investing in TIPS seems like a reasonable trade for that situation.There are then additional risks of being in a TIPS bond fund, which means you are relying on the required real rate of return to not change significantly.But my best reccommendation now is to stick with direct ownership of a bond, zero or coupon.Part of the point here is to get cheezyches to the point of understanding the risk tradeoffs - because that's what is going on. There is NO risk free investment.I don't think bonds, zeros, or CDs are a bad decision. If the bonds are TIPS, it deserves reiteration of the "distortion" point in case someone chooses to go down that path and uses TIPS. TIPS purchased on the secondary market (vs. auction from the treasury) and held to maturity may lose principal value if deflation occurs. This is a risk you take on when you buy TIPS on the secondary market which does not exist if they are purchased at auction. It is up to you as to whether you feel this is a practical risk or a theoretical one. (That discussion is getting into Master's thesis territory, IMHO)The point would be that doing the research to understand what the principal correction (aka index ratio) is on the bond is important. A TIPS issued in 2001 is riskier than a TIPS issued in 2008. Specifically, this TIPS:http://www.treasurydirect.gov/instit/annceresult/tipscpi/201...is riskier than this one:http://www.treasurydirect.gov/instit/annceresult/tipscpi/201...You can see the "index ratio" in the last column (the bond is guaranteed to pay at 100).So let's summarize:FDIC insured CD:- 100% principal guaranteed (give or take FDIC limits and the time it may take to get your check if the bank goes under and isn't subsumed into another institution)- You bear inflation risk in the form opportunity cost... in that the current payment may not keep up with inflation (you are at risk in a high-inflation scenario)Treasury Zero/Strip/Bond (non-TIP) *that matures on or before the date when you will do the project*:- 100% principal guaranteed- You may incur fees depending on the broker that you use to purchase the products (you can avoid these with certain brokers or by buying directly from TreasuryDirect)- You bear inflation risk in the form opportunity cost... in that the current payment may not keep up with inflation (you are at risk in a high-inflation scenario)Treasury Zero/Strip/Bond (non-TIP) that matures *after* the date when you will do the project:- You bear inflation risk in the form opportunity cost... in that the current payment may not keep up with inflation (you are at risk in a high-inflation scenario)- You bear interest rate risk in the form that the current price may be above or below par value at the date you need to sell to complete your project. It will be below par in higher interest rate environments, and above in lower interest rate environments (you are at risk in a high-inflation scenario and receive a benefit in a lower-inflation scenario)- You bear interest rate risk in the form of changes to required rate of real return. The current price may be above or below par value at the date you need to sell to complete your project. It will be below par in higher interest rate environments, and above in lower interest rate environments (you are at risk in a high-inflation scenario and receive a benefit in a lower-inflation scenario)TIPS that matures on or before the date when you will do the project:- 100% principal guaranteed if purchased at auction or index ratio <= 100- You bear inflation risk in the form of CPI-U accuracy... in that the current payment based on the CPI-U may not keep up with (or may be higher than) inflation in the home upgrade segment of the economy (if home repair rises faster than CPI-U you are at risk, if home repair rises slower, you receive a benefit)- You bear inflation risk in the form of CPI-U deflation risk. TIPS purchased on the secondary market (vs. auction from the treasury) and held to maturity may lose principal value if deflation occurs, as their index ratio is above 100, and the bond is only guaranteed to pay 100 at maturityTIPS that matures *after* the date when you will do the project:- You bear inflation risk in the form of CPI-U accuracy... in that the current payment based on the CPI-U may not keep up with (or may be higher than) inflation in the home upgrade segment of the economy (if home repair rises faster than CPI-U you are at risk, if home repair rises slower, you receive a benefit)- You bear inflation risk in the form of CPI-U deflation risk. TIPS purchased on the secondary market (vs. auction from the treasury) and held to maturity may lose principal value if deflation occurs, as their index ratio is above 100, and the bond is only guaranteed to pay 100 at maturity- You bear interest rate risk in the form of changes to required rate of real return. The current price may be above or below par value at the date you need to sell to complete your project. It will be below par in higher interest rate environments, and above in lower interest rate environments (you are at risk in a high-inflation scenario and receive a benefit in a lower-inflation scenario)Above and beyond those there are additional costs (fees) and risks that are present when investing in a fund rather than individual bonds/CDs/etc. I discussed that in a previous post:http://boards.fool.com/Message.asp?mid=28140978Overall:- Purchasing anything with a maturity after your project involves risks that you may perceive as investing rather than saving. This is magnified in a normal bond, but is still present in TIPS. Personally, I highly advise against purchasing any individual bonds/CDs/etc that mature after you plan to do your project. It's too risky due to potential NAV changes.- You need to think about whether you are more comfortable protecting against a high inflation scenario (buy TIPS because they protect against real inflation because the market's current perceived inflation is very low) or a deflation scenario (buy CDs/zeros/strips because TIPS have risk of losing principal due to index ratios over 100). In a constant environment, it's theoretically immaterial either way (in practice there will be pricing differences in the market that you could optimize if you really felt the Master's thesis level analysis was important)Tom
I'm having trouble getting my head around how TIPS will behave in a interest-rate rising world. I'm one of those who thinks that all the spending we are doing will eventually lead to inflation. So of course the FED wants to try to control that and they will raise rates as will the market in general. I understand that interest rates and bond prices are inversely proportional. However, in an inflationary environment, my TIPS fund should be paying more. So isn't that some protection? If interest rates stay flat, it seems it should at least be as good as a money market. What am I missing here ????
Scott,Welcome.TIPS have two components. The principal value and the fixed rate. The principal is adjusted twice a year prior to the fixed rate payout. This means that the the payout also adjusts because it is based off the adjusted principal value. In an interest rate rising world TIPS prices will adjust much in the same way as a standard treasury will, the primary difference will be the current face value of the TIPS. As rates rise, the price falls. TIPS guarantee minimum face value of 100 at maturity. The mechanics of a TIPS fund may be different because there is no maturity to a fund. As prices fall the NAV of the fund will fall. The difference will be how those face values are adjusted by CPI. In theory the NAV of a TIPS fund should lose less value than its standard Treasury cousins. An underlying condition for both the funds and the bonds is that the fixed payout tends to be set much lower than its Treasury duration peers. The rate difference is because of the CPI adjustments add some payout appreciation because of the adjustments to principal. The unknown is how fast the fixed rate will rise relative to other bonds in a rising rate environment. If the fixed rate lags TIPS holders will not benefit dramatically from their adjustments to principal.jack
ScottIn view of the microscopic rates being paid by MMF, I would think your TIPS would do a good deal better (ours are a 1.6% and 2.00%, sick but still better than MMFs).Yes, rising rates are probably reflecting inflation and inflation will improve your TIPS. BUT, the government has low-balled inflation to minimize inflation adjustments to things like Social Security and Federal annuities (This year no adjustment.), and, no surprise, to TIPS themselves. So you will get some inflation adjustment but not what your personal inflation experience will be.The danger to TIPS is deflation which is what we are experiencing now, but you are guaranteed to get back your principal.brucedoe
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