Investing - Theory, News & General • How risky is interest rate risk in TIPS ladders longer than 30 years?

Yep.

Obvious solution.

/end thread

Except StillGoing modeled this and showed that for a permanent 1% point drop across (Edit: a flat) (thanks BlenBlenBlue) yield curve occurring the day after constructing the ladder, the results are essentially identical to the strategy of holding until maturity.

Obviously rolling the 30 year TIPS over is superior since it allows less time for yields to change and protects against non-parallel shifts. But, as StillGoing stated, holding to maturity is easier to model and thus still useful in analyzing the risk.

That is my interpretation anyway.

That's not what I'm talking about.

You hold TIPS to maturity.

If you have more than you need to consume in a non-rolling ladder, you take the excess and buy the newly auctioned TIPS that extend the ladder into the future.

Example:

It's 2027, and I have TIPS maturing that year.

I have X% dedicated to consumption for living expenses.

I have Y% dedicated to buying the new 2057 TIPS to extend my ladder.

The strategy you describe trades price risk for reinvestment risk (as compared to the strategy described by RyeBourbon and myself), but I don't see how it minimizes the interest rate risk in funding spending over 30 years away via TIPS. I could be wrong. Perhaps minimizing interest rate risk is not even your goal.

You can't do anything to minimize the interest rate risk for bonds that don't exist yet and have to be purchased.

If you have to purchase them, there will be interest rate risk.

The interest rate could be anything at the time of purchase.

The best you can do is try to plan for the spending.

I think the approach you have described from "It's 2027, and I have TIPS maturing that year" is the similar to that I've modelled at viewtopic.php?p=7929841#p7929841 except (I think) that while I've assumed a target ladder length (35 years in the example I've used) you have excess (which you've named as Y%) in each of your rungs rather than a single rolling TIPS a portion of which is used to construct a new rung each year.

For me the purpose of this thread (which arose out of asking the question - how big is interest rate risk when trying to construct ladder longer than 30 years?) was to try to quantify the risk given a change in yield. I think the answers are instructive - if a short extension is required (5 years in the example I've been using), it takes a 13 percentage point drop in yields over the first 5 years of retirement before it is impossible to construct the final (35th rung). I think a drop of that magnitude is unlikely, but not impossible. However, if trying to build a 45 year ladder, it only takes a drop of 1 percentage point over the first 15 years of retirement before the final (i.e., 45th rung) cannot be constructed. That interest rate risk is more pronounced for a longer extension is probably not surprising, but the magnitude of the risk, to me at least, was.

cheers
StillGoing

Statistics: Posted by StillGoing — Fri Jun 28, 2024 4:11 am — Replies 37 — Views 2032

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