Buying TIPS On Secondary Market, Part 5: How to Buy
This is part five of the Guide to Buying TIPS On the Secondary Market. In the previous four parts of this guide, I wrote about Why Secondary Market, Understand Quotes, When to Buy, and What to Buy.
After all the prep work, this time we pull up our sleeves and really go about buying some TIPS on the secondary market.
First you need a brokerage account. If the brokerage firm you use is a small discount broker that does not handle bond orders, for example Zecco or ShareBuilder, you need to find a real brokerage firm that does. If you have accounts with several brokers or if you are buying a large amount, you may be interested in finding out which broker is most cost effective for your order. Unlike buying stocks, ETFs or mutual funds, commission is only a small part in the cost of buying bonds on the secondary market. The largest cost is the markup included in the quoted price. The markup is the price difference between what institutions pay for wholesale trades and what your broker charges you for retail purchase. The markup comes from your broker and/or the dealer from which your broker gets the bonds. A broker that charges you no commission but adds a big markup to the price can be more expensive than a broker that charges you a commission on a smaller markup. Your broker discloses the commission but it never discloses the markup.
Buying TIPS On Secondary Market, Part 4: What to Buy
This is part four of the Guide to Buying TIPS On the Secondary Market. In first three parts of this guide, we looked at Why Secondary Market, Understand Quotes, and When to Buy. Part 5 in this series will be about How to Buy.
Suppose you decided this is the time to buy some TIPS on the secondary market. But which one should you buy?
At the time of this writing, there are total of 27 TIPS bonds on the market, with maturities ranging from 2009 to 2032. Much like when you buy a flat screen TV you have to decide roughly what size you want: < 30", 30"-40", 40"-50", > 50" etc, when you buy TIPS, you have to decide what maturity range you want. A short-term TIPS (< 5 years) is less risky and it lets you deploy the money elsewhere if your plan changes, but it protects you against inflation only for a shorter period of time. A long-term TIPS (> 10 years) is more risky and you are locked in for a long time (we are only talking about buying and holding to maturity here, not trading bonds). But a long-term TIPS usually, but not always, has a higher yield and it gives you protection for a longer period of time. An intermediate-term TIPS (5-10 years) is just somewhere in between short-term and long-term. No hard and fast rules here. You pick the maturity range that suits you.
Buying TIPS On Secondary Market, Part 3: When to Buy
[Updated on December 31, 2008 with feedback from readers.]
This is part three of the Guide to Buying TIPS On the Secondary Market. Parts one and two are Why Secondary Market and Understand Quotes.
Like when you buy any other bonds, you want to buy TIPS when yields are high and prices are low. There are several places where you can monitor the TIPS market.
Vanguard, Bond Yields. This web page lists the current yields on all kinds of bonds. It used to include specific issues of TIPS in the middle of the page, but right now that section is blank. I'm not sure if it's just temporarily not available or gone for good. Keep an eye on it. Maybe the data will come back. Although the web page shows a current timestamp, it's not clear to me when the data were last updated or how frequently they are updated.
Buying TIPS On Secondary Market, Part 2: Understand Quotes
This is part two of the Guide to Buying TIPS On the Secondary Market. Part one was Why Secondary Market?
The price and yield quotes are perhaps the source of most confusion about buying TIPS on the secondary market. Unlike regular ("nominal") bonds, TIPS are quoted in real price and real yield while the actual purchase is done with nominal dollars. Let's take a look at an actual quote from Fidelity for one specific bond.
Buying TIPS On Secondary Market, Part 1: Why Secondary Market?
After reading my posts on Individual TIPS Or TIPS Mutual Fund and TIPS Auction Step By Step, some members of the Bogleheads forum asked me to write a similar guide for buying TIPS on the secondary market. If you are not familiar with inflation indexed bonds Treasury Inflation Protected Securities (TIPS), I recommend you start with a fund or ETF, then progress to participating in a few TIPS auctions before you jump into buying TIPS on the secondary market. That way you will understand better how they work. If you are ready, here we go. This is the first installment of the Guide to Buying TIPS On the Second Market. For the sake of length, this guide is limited to issues related to buying TIPS. It does not cover holding TIPS or selling TIPS.
First of all, what does buying TIPS on the secondary market mean? It means you are buying the bonds from someone who already own them. Bond dealers make a market in these bonds. They advertise a price at which they are willing to buy ("bid") and a slightly higher price at which they are willing to sell ("ask"). This is very similar to how the stock market works. Like stocks, bonds also trade on the market every day at different prices by the minute. But unlike buying stocks, retail investors usually cannot get the current market price when they buy bonds. The market price is reserved for institutions who buy and sell millions of dollars worth of bonds. Retail investors can only buy from retail brokers who often add a markup. On the other hand when you buy TIPS from auctions, you pay the same price as the institutions pay. There is no markup.
Then why should we even consider buying on the secondary market? Because most of the time we have no better choice. The Treasury department only holds TIPS auctions a few times a year (it had 8 auctions in 2008). Because the secondary market is open all year round, sometimes the prices are attractive but there is no auction. If you want to take advantage of the attractive prices, you have to buy it on the secondary market. When Treasury holds an auction, it only does it for one bond. The secondary market has all issues trading all the time. If Treasury is doing an auction for a short-term bond but you want a long-term bond, you either have to wait or you have to buy it on the secondary market.
Individual TIPS Or TIPS Mutual Fund
[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:
Subscribe
