Investing - Theory, News & General • Managing TIPS Phantom Income

However, there's still a reason to prefer lower coupon TIPS if you are not spending the coupons: coupon reinvestment risk. Your total realized return depends on the coupon reinvestment rates. A zero coupon bond as no reinvestment risk; the realized return will be the same as the original yield (roughly; IRR and YTM aren't exactly the same, but close enough).

Even in building my ladder, which in theory I will spend the coupons from, my mindset still is such that I want more certainty in my real return relative to my initial yield. This is why I choose the lower coupon Jan issues when there are two of them; I would buy all zero-coupon TIPS if they were available. Since all of my TIPS are in my IRA, I'm not concerned with OID uncertainty, but I don't think I would be either if they were spread between taxable and tax-advantaged. My inclination would be to put the longer-maturity TIPS in tax-advantaged, because there are more years of coupons and OID to be taxed, but given #Cruncher's analysis, this may not be rational either. However, I will spend down my taxable accounts first, to the extent possible, so this still warrants putting longer maturities in tax-advantaged I think.

Not sure I understand this phrase: "my mindset still is such that I want more certainty in my real return relative to my initial yield."

As you know, you can use the TIPS coupon payments as a portion of your ladder. For example, if you buy a 10 year TIPS with a 2% coupon for a 10 year ladder, in years 1-9 you would only need 98% of the principal TIPS. The coupon would pay the rest. And as you are spending the coupon as a part of the ladder, there's no reinvestment risk

How do low coupon TIPS provide "more certainty in my real return relative to my initial yield"?

Right, I acknowledge the issue in prefacing the part you quoted with acknowledging that in theory I'd spend the coupons. And my very first statement was qualified with "if you are not spending the coupons". What I'm saying is that I have an anchoring bias toward coupon reinvestment, in which case lower coupons provide more certainty in the realized return.

The reality is that I probably will reinvest the coupons, at least to some extent, especially in the earlier years. Why? My ladder is in my IRA, and have enough in my taxable account to cover expenses for years to come. So the purpose of the TIPS in my IRA, other than to preserve purchasing power, is to fund my RMDs.

I have way more in TIPS maturing in 2024-2027 than I need for my RMDs, the first of which I'll take in next year, so all coupons will definitely be reinvested in those years. I now see that I'll need to increase my ladder desired annual real income (DARA) beyond what I had planned, to ensure that there will be enough to cover the expected RMDs. In other words, the DARA I came up with for residual living expenses is less than my expected RMDs, so my RMDs should be more than enough to cover my residual living expenses.

So my situation is different than yours, and different than someone who does not have much excess beyond what's in their TIPS ladder. For someone who'll be spending most of the coupons, there is no coupon reinvestment risk, and so there is no reason to prefer lower coupons as I do.

Statistics: Posted by Jaylat — Sat Feb 17, 2024 2:14 pm — Replies 77 — Views 4617