Methods to best cover the gap years are still being developed and debated. I can only suggest what I think is a reasonable approach that seems to be "good enough" and fairly easy to implement using the tipsladder.com tool. What I am doing is as follows:
I would start by using the option "Bond maturing in the year nearest to the start of rung-year." This will populate the gap years 2036 and 2037 with the bond maturing in January 2035, and will populate the gap years 2038 and 2039 with the bond maturing in February 2040. Thus, this suggests purchasing approximately equal amounts (by cost) of excess 2035s and 2040s to cover the 4 gap years. For example, the "Purchase List" suggested by the tool for a ladder with 20K annual income for the years 2035 through 2040, inclusive (with the box checked to "Exclude pre-ladder interest from earliest funded years"), would be 56 of the 2035s at a cost of about $57.0K and 40 of the 2040s at a cost of about $58.8K.
Under present market conditions, a roughly 50/50 mix of excess 2035s and 2040s by cost has about the same average duration as the gap years would have if you could buy then directly. This "duration matching" process is useful because it minimizes interest rate risk when you later sell the excess holdings and use the proceeds to buy the actual gap year bonds when available. By duration matching, you should fairly effectively lock in today's real yield even though you will sell the excess bonds prior to maturity and swap them for the actual gap bonds.
Once the ladder is generated, you can click on the "Refine Ladder by Hand" tab in the tool. Then, by clicking on the right arrows, you can expand each rung to see the detailed holdings covering each gap year. Following the procedure suggested in this post, you can then redistribute the excess holdings among the various gap years so that the durations (calculated by the tool) are increasing in a straight line across the gap, as desired. This redistribution of the excess holdings shows what proportions to sell when sequentially swapping for each of the gap years as they become available. Again, as an example, the final distribution might look something like this (quote from the post referenced above):
I would start by using the option "Bond maturing in the year nearest to the start of rung-year." This will populate the gap years 2036 and 2037 with the bond maturing in January 2035, and will populate the gap years 2038 and 2039 with the bond maturing in February 2040. Thus, this suggests purchasing approximately equal amounts (by cost) of excess 2035s and 2040s to cover the 4 gap years. For example, the "Purchase List" suggested by the tool for a ladder with 20K annual income for the years 2035 through 2040, inclusive (with the box checked to "Exclude pre-ladder interest from earliest funded years"), would be 56 of the 2035s at a cost of about $57.0K and 40 of the 2040s at a cost of about $58.8K.
Under present market conditions, a roughly 50/50 mix of excess 2035s and 2040s by cost has about the same average duration as the gap years would have if you could buy then directly. This "duration matching" process is useful because it minimizes interest rate risk when you later sell the excess holdings and use the proceeds to buy the actual gap year bonds when available. By duration matching, you should fairly effectively lock in today's real yield even though you will sell the excess bonds prior to maturity and swap them for the actual gap bonds.
Once the ladder is generated, you can click on the "Refine Ladder by Hand" tab in the tool. Then, by clicking on the right arrows, you can expand each rung to see the detailed holdings covering each gap year. Following the procedure suggested in this post, you can then redistribute the excess holdings among the various gap years so that the durations (calculated by the tool) are increasing in a straight line across the gap, as desired. This redistribution of the excess holdings shows what proportions to sell when sequentially swapping for each of the gap years as they become available. Again, as an example, the final distribution might look something like this (quote from the post referenced above):
Please note the basic assumptions and disclosure (#4 below) which applies to this duration matching approach to covering the gap years:Using the ladder manual tool, if I try to build a 2035 to 2040 ladder with 20K of annual income, I find that I need 14 of the 2040 bonds to cover 2040 and 18 of the 2035 bonds to cover 2035. The number of bonds to cover the intervening gap years is basically a linear interpolation of the number of bonds to cover the bracket years:Just as it isn't possible to hit the Income targets exactly, the duration targets can't be matched exactly either. Juggling the mixture of bracket years covering each gap year changes the duration and income slightly one way or the other. I hope this gives a general idea of how it could be done.Code:
No. of BondsYear 2035 2040 Duration Income2040 0 14 12.81 $20,6542039 4 11 12.05 $20,6612038 8 8 11.26 $20,5762037 12 5 10.44 $20,3972036 14 3 9.91 $19,6012035 18 0 9.01 $19,862
1) Each gap year is covered by a duration-matched mixture of bracket years, such as Jan 2035 and Feb 2040.
2) The yield of each gap year is assumed to be as linearly interpolated between the present day 2035 and 2040 yields.
3) Noting that the ladder computes the interest in years prior to 2035 based on the coupons from the bracket year mix, we then make the assumption that the coupon rate of each gap year is a linear interpolation between the 2035 and 2040 coupon rates.
4) Via a disclosure, we specify that if the coupon rate of the actual gap year, when issued, differs substantially from the assumed coupon rate, then bonds may need to be swapped between the pre-gap years and gap year to correct for any major changes in interest in the pre-gap years vs principal in the gap year (a process known as ARA (annual real amount) smoothing). ARA smoothing means that the income stream will be approximately as calculated, assures that the average duration of the income stream will be approximately as assumed, and the duration matching used to hedge against interest rate changes will not be substantially degraded due to the difference between the assumed gap coupon rate and the actual, as realized, coupon rate.
Statistics: Posted by MtnBiker — Mon Feb 24, 2025 1:00 am — Replies 2 — Views 219