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VIPSX says it has returns of >= 5% over 5 years and almost 9% in the last year. It appears to be based on U.S. inflation-protected securities. However, U.S. treasuries are returning near zero, and inflation is near zero.

Explain.

P.S. This answer recommends inflation-protected securities, so I'm curious.

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    Perhaps they're lying ... ;) Dec 15 '10 at 1:24
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Without having researched that particular fund, I believe that they bought bonds in the past, say five years ago, interest rates were higher. As the interest rates have dropped, those bonds became more valuable, so their price rose. As a result what you are seeing is not just the direct interest rate that bonds have, but also the boost that bonds get when interest rates fall. Of course, in the future, if interest rates should rise, then you'll see the opposite effect where bond funds will deliver lower returns.

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    It's an inflation-protected bond, not inflation-protected cash. They can still return real interest and fluctuate in value. Buying TIPs is basically the same as buying a regular Treasury bond and then buying some inflation insurance for that amount (except with less risk that the guy selling you the inflation insurance will go out of business - counterparty risk).
    – user296
    Dec 16 '10 at 19:04
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Knox's answer is correct, but I wanted to elaborate a bit.

The price for an individual bond increases as interest rates decrease.

If you buy a bond that pays 5% at par (100), and next year a similar bond yields 3%, people will pay a premium if you sell the 5% bond (which varies based on a number of factors, but the bond would sell at a rate greater than 100), since you are yielding a higher interest rate. Conversely, if rates go up, that 5% bond will sell at a discounted rate (less than 100).

With VIPSX (the Vanguard TIPS fund you referenced), the fund's portfolio page has alot of useful information, including a listing of the specific bonds in the portfolio.

TIPS bonds are also a little unusual, because the inflation protection gets added to the principal -- so even if there isn't any inflation, the bonds prices will still fluctuate as rates rise and fall.

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  • I know how the math works, but it still nags at the back of my mind that there's something wrong with the idea that if a bond is paying 5% and a new bond of the same kind is paying 3% that I would somehow pay a premium for the 5% bond. No the heck I wouldn't because that would negate the whole higher interest rate in the first place!
    – user12515
    Nov 10 '21 at 16:16
  • @Michael If the price premium negates the difference in the coupon rate, then you should be indifferent between the two bonds. You can get the market yield by buying a bond with a lower coupon at par, or you can get it by buying a bond with a higher coupon at a premium. Either way, you're going to earn the going rate. And in practice this is more or less what happens.
    – Nobody
    Nov 10 '21 at 19:52
  • @Nobody Yeah but... and this is probably a bit irrational, I'm not completely indifferent between the two. I feel like I've missed out on something with the 5% bond, so I'm going to want more than 3%. It may not be much more than 3%, but I feel like it should have a slight premium, because as pricewise I should be indifferent, why should I give the 5% holder an out at a higher price than they paid just because they got lucky on interest rates? So in my mind at least that makes the 5% at least slightly less desirable, all other things being equal.
    – user12515
    Nov 10 '21 at 21:04
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    @Michael Interesting. I suppose you could say the same about any asset that appreciates in value. E.g., why should you pay the owner of a stock a higher price just because the company had a better than expected earnings report? Anyway, the point is that for most investors these are two different ways of achieving the same result. Though, come to think of it, I suppose the different tax treatment of interest payments vs. capital gains makes them not exactly equivalent.
    – Nobody
    Nov 10 '21 at 21:27
  • @Nobody Dunno... assets seem different somehow. Maybe I'm just salty about negative real interest rates right now.
    – user12515
    Nov 10 '21 at 21:57

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