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TIPS pay a positive real rate of return, in the case of the last auction 1/8% real return.
That's different from nominal rate of return. Let's take that one first, because people are more familiar with it. Say a bond pays 3%, but inflation is running at 4%. Then each year, people are losing 1% in value. Are they paying for the "privilege" of losing value? I would say so, but I dare say many people would disagree, asserting that they're getting 3% return, though they're getting paid back in devalued dollars.
Now suppose you had a bond that paid no (nominal) interest - a 0% bond, but also suppose that we were in a period of deflation. Are people lending their money for free? Again, one can look at the value of their investment. When the bond matures, they get their money back in dollars that are worth more than the ones they lent. So they've gotten a real return (simply by forsaking spending those dollars in this example, regardless of whether they lent the money or not).
With TIPS, investors are looking not at the numeric value of their investment (i.e. whether they are getting paid 0%, 3% or whatever), but rather how much more their investment is worth at the time of redemption than now. That is, the real return. Investors buying the 10 year TIPS are guaranteed 1/8% (per year) more value than they started with. A real (in multiple senses of that word) positive return. If they wind up getting paid back in dollars that are worth less than the ones they lent (i.e. the usual case of some positive inflation), then they'll get paid their 1/8% plus some additional amount to compensate for the loss of value of those dollars. If they wind up getting paid back in dollars that are worth more than the ones they lent (i.e. deflation), then the payment will similarly be reduced to compensate for the fact that those payback dollars are dearer than the ones they originally lent.
No mystery here. At the moment, the inflation rate is negative; if it were to continue this way for 10 years, they'd be paid back with fewer dollars than they lent, because the dollars would be worth more(*). But they'd still get their 1/8% extra value out of the deal.
(*) Technically, TIPS never pay back less than the nominal amount lent (paid for the bond). So if there really were net deflation over a period of 10 years, you'd come out ahead - getting paid the full face value, but in dollars that were worth more than originally lent. (That, plus the 1/8% / year interest.)
Specifically, the CPI-U for Nov 2011 was 226.230, and for December 2011 225.672, meaning that there was deflation.
As to the bonds; our house is not really yield chasing, realtive to a high yield. The preference is the downward yield move as a result of other buyers and thus driving the pricing higher. This is where the profits have been for awhile. We'll hang around a bit longer; and hopefully notice the exit sign flashing at the proper time. There are 3 year bond charts that are a bit smoother than this one; but every investor likes to find these nice lines moving upward from left to right.
Comments
It will just be worth less in inflation adjusted terms.
That's different from nominal rate of return. Let's take that one first, because people are more familiar with it. Say a bond pays 3%, but inflation is running at 4%. Then each year, people are losing 1% in value. Are they paying for the "privilege" of losing value? I would say so, but I dare say many people would disagree, asserting that they're getting 3% return, though they're getting paid back in devalued dollars.
Now suppose you had a bond that paid no (nominal) interest - a 0% bond, but also suppose that we were in a period of deflation. Are people lending their money for free? Again, one can look at the value of their investment. When the bond matures, they get their money back in dollars that are worth more than the ones they lent. So they've gotten a real return (simply by forsaking spending those dollars in this example, regardless of whether they lent the money or not).
With TIPS, investors are looking not at the numeric value of their investment (i.e. whether they are getting paid 0%, 3% or whatever), but rather how much more their investment is worth at the time of redemption than now. That is, the real return. Investors buying the 10 year TIPS are guaranteed 1/8% (per year) more value than they started with. A real (in multiple senses of that word) positive return. If they wind up getting paid back in dollars that are worth less than the ones they lent (i.e. the usual case of some positive inflation), then they'll get paid their 1/8% plus some additional amount to compensate for the loss of value of those dollars. If they wind up getting paid back in dollars that are worth more than the ones they lent (i.e. deflation), then the payment will similarly be reduced to compensate for the fact that those payback dollars are dearer than the ones they originally lent.
No mystery here. At the moment, the inflation rate is negative; if it were to continue this way for 10 years, they'd be paid back with fewer dollars than they lent, because the dollars would be worth more(*). But they'd still get their 1/8% extra value out of the deal.
(*) Technically, TIPS never pay back less than the nominal amount lent (paid for the bond). So if there really were net deflation over a period of 10 years, you'd come out ahead - getting paid the full face value, but in dollars that were worth more than originally lent. (That, plus the 1/8% / year interest.)
Specifically, the CPI-U for Nov 2011 was 226.230, and for December 2011 225.672, meaning that there was deflation.
TIPS In Depth from TreasuryDirect.
As to the bonds; our house is not really yield chasing, realtive to a high yield. The preference is the downward yield move as a result of other buyers and thus driving the pricing higher. This is where the profits have been for awhile. We'll hang around a bit longer; and hopefully notice the exit sign flashing at the proper time.
There are 3 year bond charts that are a bit smoother than this one; but every investor likes to find these nice lines moving upward from left to right.
http://stockcharts.com/h-sc/ui?s=FINPX&p=W&yr=3&mn=0&dy=0&id=p95974693617
Opps...1 minute later and this dropped into the mail inbox (a forum unknown to me); but one writer notes the yield changes relative to TIPS in 2011.
http://tickerforum.org/akcs-www?post=200793
Gotta git.....take care of you and yours,
Catch