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TIPS Auction Step By Step: Read the Results

TFB — Thu, 10 Jul 2008 17:38:00 +0000

[An updated version of this article appears in my new web site Explore Bonds, together with many other articles on investing in bonds.]

This is the fourth installment in my TIPS auction series. The previous posts in this series were:

The auction for the 10-year TIPS is completed today. The Treasury Department publishes the official auction results on their website. The results for this auction show that the yield is 1.485%. Because this is a new issue, the coupon rate is rounded down to the nearest 0.125%, which is 1.375%. Each bond of $1,000 face value will cost $989.81282.

This is within my previous estimate of between $988.82 and $1,000. It also matches the result calculated by my TIPS pricing spreadsheet if you plug in the 1.485% yield (of course you don’t know this number until now).

The auction results also show some other interesting data points. Total $8 billion worth of bonds were sold in this auction. Total bids received were $14.6 billion. The orders from retail investors (”noncompetitive bids”) were only $88 million, which were 0.6% of the total bids or 1.1% of the total bonds sold. Yet this 1.1% of orders received the same price as what the big guys received. That is a very good deal to individual investors.

We can also see that from the Treasury Department’s point of view, selling TIPS is a hundred times more efficient than selling Savings Bonds. They were able to sell $8 billion worth of bonds in one morning. According to this news article, the total sales of savings bonds (series I and EE combined) in the last ten years were:

Fiscal Year (Oct. 1 – Sept. 30)	Sales
2007	$3.4 billion
2006	$8.3 billion
2005	$6.3 billion
2004	$7.9 billion
2003	$11.8 billion
2002	$9.8 billion
2001	$6.6 billion
2000	$5.2 billion
1999	$4.7 billion
1998	$4.8 billion
Average	$6.9 billion

If you were in charge of selling bonds at the Treasury Department and you know you can sell more TIPS in one morning than what you can sell I Bonds in an entire year, plus you don’t have to print or mail those paper bonds, what would you prefer to do? No wonder they set the rate on I-Bonds so low (currently at 0%). TIPS are a win-win for both the Treasury Department and the investors.

Next step: If you placed an order in this auction, you will receive the bonds on July 15, 2008 (Issue Date) and pay $989.81 per $1,000 face value. If you didn’t buy in this auction, a new announcement for a 20-year TIPS will come out on July 17, 2008.

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TIPS Auction Step By Step: Place Order

TFB — Tue, 08 Jul 2008 14:26:00 +0000

[Updated on July 11, 2008: added related posts in the series.]

This is part three of the TIPS auctions series. Other posts in this series are:

If you are interested in TIPS but you don’t want to be bothered with auctions, you can buy TIPS in a mutual fund or ETF. See Individual TIPS Or TIPS Mutual Fund.

Say you decided to buy some TIPS from the auction. How do you place your order? Although it’s an auction, you don’t really enter a bid as you do in an eBay auction. Only financial institutions who buy TIPS in the millions bid in the auction. You get to tag along with a so called “non-competitive bid” which means you accept the final price from the auction no matter what it is. And that’s not a bad thing. Because all orders — from the big guys, and you — get the lowest price (highest yield) from the auction, your small non-competitive bid for $10,000 is treated the same as a $100 million bid from a bank. Isn’t that nice?

If you are going to buy TIPS in a taxable account, you can buy them from TreasuryDirect. If you want to buy in an IRA, you have to use a brokerage account. Fidelity and Schwab are good brokerage choices because they don’t charge any fees for buying TIPS at auction. You can also buy from Vanguard Brokerage Service, but you may have to pay a $10 fee unless you have over $100,000 with Vanguard.

I don’t have an account with TreasuryDirect so I can’t show you how to place an order there.

In Vanguard Brokerage Service, it’s under View and trade bonds or CDs, then Treasury Auction. Vanguard Brokerage Service requires a minimum order of 10 bonds or $10,000 in face value.

In Fidelity, it’s under Trade Fixed Income, then Search Inventory, then TIPS (Auction). The minimum order size at Fidelity is 1 bond or $1,000 in face value.

Enter the number of bonds you’d like to buy (1 bond = $1,000 in face value). You cannot specify any price limit because your order will be a noncompetitive bid.

The official closing time for this 10-year TIPS auction is 12:00 noon Eastern Time on July 10, 2008. If I were to buy from this auction, I’d make sure that my order is placed before 4:00 p.m. Eastern Time on July 9, 2008. That is before the end of the business day prior to the auction date.

Next step: read the auction result.

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TIPS Auction Step By Step: Read the Announcement

TFB — Tue, 08 Jul 2008 05:39:00 +0000

[Updated on July 11, 2008: added related posts in the series.]

This is part two of the TIPS auctions series. The other posts in the series are:

If you are interested in TIPS but you don’t want to be bothered with auctions, you can buy TIPS in a mutual fund or ETF. See Individual TIPS Or TIPS Mutual Fund.

The Treasury Department publishes auction announcements on their website. The announcement for the upcoming 10-year TIPS auction on July 10 came out today (link). It’s close enough to the auction date now. If you’ve been thinking about it, you should decide now whether you want to buy from this auction.

1. Estimate the Yield. You will not know what the yield will be until the auction is over, but you can take a guess using the current yield on existing bonds which are traded on the secondary market. I use the Daily Treasury Real Yield Curve Rates published by the Treasury Department and the yield charts by Federal Reserve Bank of St. Louis: 5-year, 10-year, and 20-year.

The current yield on a 10-year TIPS is 1.43%. The yield from the auction should be around that number. Remember this 1.43% number is the real yield, which is above and beyond the reported inflation number. The current real yield is below the average real yield we’ve seen in the past few years, although the reported inflation number is higher than before. You have to decide yourself whether this is a good yield for you or not. For me, I decided to skip this auction and look at the 20-year issue coming up in about two weeks. Sometimes the yields on 10-year and 20-year TIPS are close to each other (”flat yield curve”) but at this time there is a large difference (”steep yield curve”). As you can see from the chart below, the 10-year (blue line) was close to the 20-year (red line) in 2006 and most part of 2007. Lately it has dropped below the 20-year by quite a bit.

If you decide to buy the 10-year TIPS and you’d like to get a handle on how much money you will need, you will need some data from the announcement to do the calculation.

2. New Issue vs. Reopening. The 10-year TIPS this time is a new issue, which means it’s a brand new bond the market has never seen before. If it were a reopening, it will say so in the announcement. The next auction for a 20-year issue is going to be a reopening, which means the Treasury Department will issue additional bonds with the same terms as the existing bonds they sold before. A difference between a new issue and a reopened bond is the stated interest rate or the “coupon” rate. The coupon rate on a new issue is determined by the auction. It’s set to the nearest 0.125% below the high yield in the auction. The purchase price is also adjusted accordingly. For a reopened bond, the coupon rate is fixed. The auction will determine only the price. Another difference between a new issue and a reopened bond is the inflation adjustment. Because a reopened bond has been on the market for some time, it has accumulated some inflation adjustment. A reopened bond typically costs more in nominal dollars unless its coupon is significantly below the current market yield.

3. Important Dates and Index Ratio. The announcement contains many data points but only these are relevant for estimating how much a bond will cost.

Issue Date: the date you will officially own the bond
Maturity Date: the date they will pay you back
Dated Date: the date from which the interest payment will be calculated
Interest Rate (reopening only, not applicable to new issues): the coupon rate
Index Ratio: the principal adjustment factor

4. Estimate Dollars Needed. Plug in the data you gathered from above together with your yield estimate into my TIPS pricing spreadsheet. You will see roughly how much you will need for each bond. By my estimate, with the yield within +/- 0.10% from 1.43%, you will need between $988.82 and $1,000 per $1,000 face value.

Next step: place order if you are going to buy it.

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TIPS Auction Step By Step: Know the Schedule

TFB — Thu, 26 Jun 2008 03:04:00 +0000

[An updated version of this article appears in my new web site Explore Bonds, together with many other articles on investing in bonds.]

There will be two auctions for Treasury Inflation Protected Securities (TIPS) in July. I will follow these auctions in a series posts. This is the first post in this series. Other posts in the series include:

Tentative Auction Schedule. How do you know when they will hold an auction for what? The Treasury Department publishes a tentative auction schedule a few months in advance. Although it is said to be tentative, the schedule is pretty much set once it’s published. I’ve never seen an auction being canceled or moved. The schedule includes auctions for Treasury bills, regular (”nominal”) Treasury notes and bonds and TIPS. The TIPS auctions are shaded in blue so they are easy to spot.

There are three dates in the schedule.

1. Announcement Date. The Announcement Date is when they publish a formal announcement. The announcement will contain more detailed information about the bond being auctioned. You can’t place an order until the Announcement Date.

For the next two auctions, we know the Announcement Dates are Monday July 7, 2008 for a 10-year TIPS issue and Thursday July 17, 2008 for a 20-year TIPS issue.

2. Auction Date. The Auction Date is the date when they actually hold the auction. The cutoff time is specified in the announcement, usually around 12:00 p.m. Eastern Time. Your order must be received on or before the auction cutoff time on the Auction Date. If you place order through a brokerage account, the brokerage firm may impose its own cutoff time before the official cutoff time to allow itself time for transmitting your order to the Treasury. For example the current cutoff time at Vanguard Brokerage Service is 9:30 a.m. Eastern Time for online orders or 10:00 a.m. Eastern Time for phone orders. To play it safe, I usually place the order at least one business day before the Auction Date.

For the next two auctions, the actual Auction Dates are Thursday July 10, 2008 for a 10-year TIPS issue and Tuesday July 22, 2008 for a 20-year TIPS issue.

3. Settlement Date. The Settlement Date is the date when you actually pay and receive the bonds. You must have enough cash ready on this date.

For the next two auctions, the Settlement Dates are Tuesday July 15, 2008 for a 10-year TIPS issue and Thursday July 31, 2008 for a 20-year TIPS issue.

Next step: read the announcement on July 7.

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Individual TIPS Or TIPS Mutual Fund

TFB — Sun, 17 Jun 2007 14:26:00 +0000

[An updated version of this article appears in my new web site Explore Bonds, together with many other articles on investing in bonds.]

A reader asked about TIPS mutual funds in the comments to my action plan for TIPS. Just like there are mutual funds which invest in stocks, there are mutual funds that invest in TIPS. The Vanguard Inflation-Protected Securities Fund (VIPSX) is a popular choice because of its low 0.20% expense ratio. Similar funds from Fidelity or T. Rowe Price charge double what Vanguard charges. There is also an ETF iShares Lehman U.S. Treasury Inflation Protected Securities Bond Fund (TIP), whose expense ratio is also 0.20%, but it only makes sense if you have a no-commission brokerage account like WellsTrade or Zecco because otherwise you would have to pay brokerage commission for each trade. There’s another newer ETF SPDR Barclays Capital TIPS ETF (IPE) with 0.1845% expense ratio. Vanguard also filed an application with the SEC for an ETF based on its fund. It’s not on the market yet.

Buying TIPS through a mutual fund (or ETF) is a good idea, because it gives you a lot of convenience for a small price. Pros for investing in a fund include:

1. Buy at any time without a transaction fee. Although there is no charge to buy individual TIPS bonds at auctions through certain places (Fidelity, Schwab or TreasuryDirect), the auctions only come up a few times a year. If you want to buy individual TIPS bonds when there’s no auction, you must use a brokerage account. Some brokerage firms charge a commission for bond orders. Vanguard charges minimum $40. You also pay a higher price (”markup”) than the wholesale price when you buy on the secondary market. Or you will just have to wait until the next auction, but the prices will have changed by then.

2. Instant diversification. A mutual fund holds about 20 bonds with different maturities. You get all of them with one purchase. If you are buying individual TIPS bonds, they don’t come on auction at the same time. You must wait for the auctions or pay commissions to establish your positions.

3. Sell at any time without a transaction fee. If you have individual TIPS bonds, there is no fee if you wait until they mature. If you want to sell before they mature, you may have to pay a commission. TreasuryDirect charges $45. Vanguard charges at least $40. You also receive a lower price (”markdown”) than the wholesale price when you sell on the secondary market.

4. Buy or sell for any random amount. Minimum additional investment in the Vanguard TIPS fund VIPSX is $100. Want to buy $456.78? No problem. The individual TIPS bonds are in $100 increments at TreasuryDirect or in $1,000 increments in a brokerage account.

5. Reinvest interest payments immediately without charge. If you have individual TIPS bonds, you must hold the interest payments elsewhere. Reinvesting in another TIPS bond is also subject to the auction cycles and $100 increments at TreasuryDirect or $1,000 increments in a brokerage account.

6. Easy tax handling (for taxable accounts only). TIPS bonds in a taxable account have a unique phantom income issue. I won’t go into the details here. The fund shields that issue away from you. You receive regular dividends from the fund and you get a 1099 at the end of the year, just like any other mutual fund.

All of these convenience come at a cost of 0.20% a year for the Vanguard TIPS fund VIPSX. That’s $20 a year for each $10,000 invested. If you have $100,000 or more for TIPS, Vanguard’s fund offers Admiral shares which cut down the expense ratio to 0.11%, or $11 a year per $10,000 invested. It seems very reasonable to me. Why bother buying individual bonds then? Because,

1. Low expenses. If you buy at auctions and hold to maturity, there is no extra expense. If you buy a large amount of TIPS, you can save money by building your own fund with individual bonds. Fidelity, Schwab and TreasuryDirect charge no fee or commission if you buy at auctions and hold to maturity. Even if you buy on the secondary market, as long as you buy long-term bonds in large chunks and hold the bonds to maturity, a one-time commission and markup can be less expensive than having to pay an ongoing expense year after year.

2. Be your own fund manager. You get to decide what maturity you buy. When you buy fund shares you buy a basket. The fund’s (experienced) managers decide what to buy and when to buy. With individual bonds, now you become the (amateur) manager for your own fund. Want short maturities? Buy 5-year notes. Want long ones? Buy 20-year bonds.

I’ve bought all of these before, the Vanguard TIPS fund VIPSX, the iShares ETF TIP, and the individual bonds. They all worked the way they’re supposed to. Right now I’m buying individual bonds and holding them to maturity because I want to save the ongoing expenses.

Buying at auctions and holding to maturity is not that hard. I have a step-by-step guide for doing so. If you buy long-term bonds at least $10,000 at a time, the secondary market can also be cost effective. If the the yield becomes attractive between auctions, I will not hesitate to buy on the secondary market. After all, for a 20-year bond, paying a one-time 1% commission plus markup beats paying a 0.2% expense every year for 20 years.

Follow up posts:

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