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Bond Ladders Look Attractive Today With TIPs


Are you looking for a safe and reliable way to generate income during retirement? Bond ladders might be the answer you’ve been searching for. While the idea of using bonds to secure cash flows had lost popularity in recent years, the current market conditions make bond ladders an intriguing option.

Interest rates in the US remain high, even as inflation is relatively low. This has resulted in reduced bond prices and higher yields to maturity compared to expected inflation rates, which can work in favor of retirees.

The Rise of Treasury Inflation-Protected Securities (TIPs)

Treasury Inflation-Protected Securities (TIPs) have gained popularity as an investment option. These bonds, introduced in 1997, have seen rapid growth and are currently issued in maturities of 5, 10, and 30 years. With nearly $2 trillion in outstanding bonds, TIPs have become a significant investment that shouldn’t be ignored.

One of the distinguishing features of TIPs is that their underlying principal adjusts based on changes in the Consumer Price Index (CPI) every six months. While short-term price movements may be unpredictable, holding TIPs until maturity can provide a reliable hedge against inflation.

To understand the potential benefits of TIPs, consider the following example:

Suppose you invest in an inflation-protected security with a face value of $1,000 and a 3% coupon. In the first year, you receive $30 in two semi-annual payments. If the CPI increases by 4%, the face value is adjusted upward to $1,040. In the second year, you receive a 3% coupon based on the adjusted face value, resulting in an interest payment of $31.20. As inflation fluctuates, the adjustments to the face value and interest payments continue, providing a level of protection against inflation.

The Allure of Bond Ladders

Bond ladders offer a practical and structured approach to managing your investments. By creating a ladder with bonds maturing at different dates, you can ensure a steady stream of cash flows aligned with your financial goals. Let’s explore how you can implement a bond ladder using TIPs:

Start by purchasing a TIP with a face value of $10,000 maturing in 2053. For each subsequent year, you can adjust the amount invested by taking into account the interest generated by the previous bond, based on a conservative assumption of a 2.0% real interest rate. By working backwards, you can gradually build a bond ladder that suits your needs.

Keep in mind that there is a temporary gap between 2034 and 2039 where there are no 30-year TIPs available. However, the US Treasury regularly auctions 10-year TIPs, which can help fill this gap when they mature in the barren period. This strategic approach can mitigate risks associated with the lack of available maturity dates.

If you’re interested in exploring bond ladders further, you can use online tools like tipsladder.com to get an initial draft of the TIPs you’ll need to purchase. For example, based on a scenario where each rung of the ladder generates $10,000 over a 30-year period, the estimated cost would be approximately $224,000.

Embracing the Benefits of TIPs

Why consider TIPs in your investment strategy? Firstly, real yields are currently around 2.0%, and they tend to operate for an average of 15 years. This means that a bond ladder with a total investment of $300,000 could be discounted by around 34%, resulting in an estimated cost of $223,000.

Additionally, the recent increase in inflation concerns has sparked renewed interest among investors in protecting themselves against future price increases. This is evident from the increase in online searches related to inflation, indicating a growing awareness of the topic.

Lastly, the TIPs market is highly liquid, providing liquidity at various maturities except for the temporary “doughnut hole” between 2034 and 2039. With bid/ask spreads within a narrow range and prices well below par value, investors have an opportunity to access the TIPs market at attractive rates.

It’s important to note that a TIPs ladder is a fully amortizing investment, meaning that there is no residual value once the ladder is exhausted. However, the 30-year time frame aligns well with many investors’ retirement horizons. For those with shorter time horizons or different financial goals, bond ladders of 10 or 20 years can be a flexible alternative.

Start building your bond ladder with TIPs today and enjoy the benefits of stable cash flows, protection against inflation, and a structured investment approach that fits your long-term financial goals.