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Trying to Understand TIPS

Submitted by spillane56@veri... on 11 February 2010 - 10:53pm

ESPlanner shows that the long-term rate of return for TIPS is 2.84%. Since TIPS are designed to keep pace with inflation, shouldn't I be setting the inflation rate to 2.84% to correctly illustrate having a 100% TIPS portfolio throughout my lifetime?

I assume this means a 0% real rate of return.

Rick

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Submitted by Dick Munroe on 12 February 2010 - 6:11am.
1

Nope. The TIPS rate is real, so whatever you set inflation to, you'll get 2.84% return.

Best,

Dick Munroe

Submitted by spillane56@veri... on 12 February 2010 - 6:17pm.
2

Thanks Dick for the quick reply.

As a follow-up, and this is more of a general TIPS question than it is an ESP question, does a 2.84% real return on TIPS mean that TIPS are actually beating inflation? If so, could this be the result of TIPS trading on the secondary market?

I would thnk that if I only bought original issue TIPS directly from the treasury at auction, that I would only be guaranteed to earn the inflation rate (i.e., net zero real return). If this is the case, would I be better off modeling this scenario by turning off Monte Carlo and simply setting a nominal rate that is equal to the inflation rate?

Excuse my ignorance if this is a stupid question. I missed a few math classes in school.

Thanks,

Rick

Submitted by Dick Munroe on 13 February 2010 - 7:05am.
3

TIPS always beat inflation, that's the point of TIPS. To figure out the nominal rate of return for TIPS, multiply:

1.0284 * ( 1 + inflation )

which, for inflation = 3%, results in:

1.059252

If inflation varies, the nominal interest rate varies but the real interest rate remains pegged at 2.84%

Best,

Dick Munroe

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