TIPS Price Up: Buy, Hold, Or Sell?

US Treasury sold 30-year TIPS at 2.19% real yield in February 2011. I didn’t buy it because the maturity is too long for me. Now, not mere three months later, the value of this bond has gone up substantially. Had I known it would do this well, I should’ve put a lot of money in it.

Back in February, investor paid $987 for each $1,000 bond. As I’m writing this post, you can sell this bond for $1,113. That’s a gain of nearly 13% in three months. The stock market went up maybe 2% during the same time. Who says you can’t make more money in bonds?

If you bought this bond in February, should you buy more, hold it, or sell it? I’m using this bond as an example to show the analysis that I apply in any buy, hold, or sell decisions for TIPS.

The real yield on this 30-year TIPS bond maturing in 2041 is 1.7% if you buy it now. That means if you hold it to maturity and reinvest all the interest payments at the same rate of return from this point onward, you will earn 1.7% plus the rate of inflation until the bond matures in 29 years and 9 months.

That 1.7%-above-inflation number is below the historic average, but as we should know, nobody has a time machine. Receiving a historic average return isn’t any investor’s given right. We can only do the best we can with the cards we are dealt with.

Fortunately we don’t have to just buy this TIPS bond or buy nothing at all. There are other maturities to choose from. There are also other types of bonds and other investments beyond just bonds.

Investment advisor and author Larry Swedroe wrote in his TIPS Update for May 2011:

"And with real yields still below their historic averages for TIPS, you may not want to extend maturities much further than about 15 years or so."

If you agree with Larry Swedroe’s analysis, you shouldn’t buy this 30-year TIPS bond because 15-year TIPS are a better value than 30-year TIPS.

What if you already have it? Should you hold it? If you don’t buy it when you have cash but no TIPS, it would be logically inconsistent to hold it. The cost of selling is very minimal. Holding it is logically equivalent to selling it for cash and turning around to buy it again.

If you won’t buy it when you don’t already own it, you should sell it. Hold it only if you are willing to buy it at today’s price if you don’t already own it.

When someone bought the 30-year TIPS in February, they were expecting to earn 2.2% a year plus inflation. Three months later, inflation went up 1.4% but the bond appreciated 13%. Basically the market handed you next five years of expected returns in three months. I would be happy to take that offer and move on to something else.

If you sell it, what do you do with the cash then? You can buy 15-year TIPS as Larry Swedroe suggested, or you can buy I-Bonds. Both will give you inflation protection at a lower risk than the 30-year TIPS.

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Comments

  1. Chuck says

    I bought 9. You’re right, it’s tempting to sell it and wait for the pendulum to swing again. Then again, I might have bought it at 1.7% yield anyway.

  2. enonymous says

    Your argument is perhaps a bit unconvincing…

    My TIPS are in my company 401k plan (I can buy individual bonds through it).
    I could sell them (I bought many of these in late 2008 TIPS had a market dislocation event), but I can’t buy enough I-bonds to replace them. Moreover, I can’t buy my I-bonds in tax deferred space (debatable if I’d want to anyway).

    Buying and selling TIPS through Fidelity (my 401k broker) is not without transaction fees. My estimate is that they take close to a 1% bite on a round trip purchase and sale of the bond (due to fairly wide bid-ask spreads – my ability to ‘middle them’ has been poor at best). So to sell one buket of TIPS and buy another, for each $1000 I’m looking at a $10 cost. This is a pretty important transactional cost drag.

    All of the analysis assumes that there is some market itming possibility in TIPS – and I agree, there is, but the market must dislocate severely (think early 2008 with very negative real yields, then again late 2008 with 20+ yr TIPS at 3-3.5% real yields).

    When the dislocation from historical norms is significant, then it makes sense to bear the transactional costs. I just don’t feel that we are currently in such a situation. I coul, of course, be entirely wrong…

  3. Harry Sit says

    @Chuck – Since you are willing to buy at the 1.7% yield, you are a perfect candidate for holding it.

    @enonymous – After a 13% gain in such a short period, a 1% transaction cost isn’t bad at all. A 5 basis point move in the yield will cause a 1% change in the price. If you look at the daily yield history for this bond, you will see it swings 1% every 3-5 days all the time. That’s why I don’t see the transaction cost as a big deal.

    The key is whether you are willing to buy at the current price if you don’t already own it. If your answer is the same as Chuck’s, holding it is perfectly fine.

  4. enonymous says

    but if I sell, what would I buy for inflation protection?
    not I-bonds for the reasons I outlined.
    15 year TIPS? I guess, but the 1% round trip transaction cost is an actual cost. the 1% price fluctuation doesn’t mean anything to me since I can’t reliably time the market to capture/avoid those 1% fluctuations.

    Would I be willing to by and sell an index fund if there was a 1% transaction fee? NO. But index funds fluctuate 1% all of the time…

    I generally agree with you but your logic on that line of reasoning is flawed at best…

    I agree that 1.7% purchased vs held is basically the same, in a no transaction cost world. In a world with those fractional costs, 1.7% to purchase is NOT the same as 1.7% that I hold – since getting out of the bond and buying something else cuts my returns by 1%! Right now most checking accounts are yielding 1% at best (+/-) after tax. So here I need to spend 1% (not even annualized…) to execute this ‘strategy?’ Does not make sense…

  5. Harry Sit says

    With transaction cost 1.65% to purchase is 1.70% held. Other than the endowment effect, I can’t see how one’s buy/sell decision could be that finely tuned — “I will buy if I get 1.70% plus inflation but I won’t buy if I only get 1.65% plus inflation.”

  6. Pelon says

    @TFB

    You know a lot more about TIPS than I, so please review my thoughts and let me know if my reasoning is flawed:

    I view TIPS as less of an investment and more of an inflation hedge. I’m trying to maintain purchasing power as much as possible and am willing to give up a potentially greater real return on other investments in exchange for the ability to lock in a known real return on the TIPS (not factoring in problems with CPI calculations and other things which could affect the real return). The only thing that would lead me to sell my TIPS for other than normal asset allocation reasons would be if the real return fell below what I believe I could easily get elsewhere. That is unlikely to ever happen.

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