Have you changed your approach to hedging against inflation?

[Maurice]

Just curious if anyone here has changed their target AA based on increased concern you may have against inflation.

I have made some adjustments, but I don't think I'm done yet. The main one is that all of my bonds are now inflation linked.

I should add that when my AA was set up (~7-8 years ago) I was already bearish on the dollar.

 

[ziggy29]

I have about 60% of my bonds in TIPS now, but that only protects against government-reported inflation, not true inflation...

 

[Marcretire]

One word: TIPS

 

[Koolau]

Will probably keep my I-bonds until all other "cash-like" accounts are used up. I like that you can cash them in and have say 1/2 taxable, 1/2 non-taxable, depending upon the interest accrued. This allows you to "titrate" your taxable income in a given year - i.e., cash in enough to just keep yourself within a certain tax bracket, but actually end up with more cash than the taxable portion. Wish I had taken out more of these when it was a good deal, interest wise. Too late to the party, that's me!

Seriously considering transferring some of my more cash-like (AKA old SPDAs paying a guaranteed 4.5%) Trad. IRAs to VG TIPS fund, but I've got more research to do on that. What do others think about TIPS funds (especially of the VG persuasion?)

My other inflation hedge will be to purchase more equities as I re-characterize Trad. IRAs to Roths. The theory I always hear is that equities (though with a stormy ride) outpace inflation in the long run. At almost 62, not sure I have a long run in store, but... Don't know if this is a good move or not. Ask me in 20 years.

RE: The dollar: Need to do more research into unhedged OUS funds. I'm very weak on this sort of thing. Now that they (and everything else is beaten down) might be a time to dip a toe into the water. We'll see. Probably, you should watch what I do and then do the opposite, 'cause YMMV, heh, heh.

 

[FIREd]

Against inflation: equities, TIPS, commodities (gold, silver, oil mostly), real estate

Against further weakness in the USD: foreign equities, foreign currencies.

I have almost no cash on hand in my investment accounts.

 

[Poundkey]

I always thought the dab of corn and soy beans I got from our small farm in Iowa was somewhat of a hedge. Over the past year grain prices topped then fell pretty much in step with oil, and prices now are well below what I expected compared to what I paid for seed and fertilizer. I'm still holding all my corn and half my beans at the coop, but there are costs involved with that too. Oh well....

 

[headingout]

I have equities, metals, natural resources, real estate, TIPS holdings. But lately I've been having second thoughts about the inflation specter, especially as it relates to holding equities. Inflation hasn't been a big issue in recent years, and is not a problem right now. Of course everybody "knows" that inflation ought to be an issue in the future, given all the proposed government spending. But inflation isn't going to sneak up on us. It will take at least a few years to develop, and it will do its damage over a long period of time, during which antidotes can be applied. By contrast, the bottom can fall out of equities in a matter of days (last Fall). Conclusion: I'm less sold on the potentially self-serving financial industry mantra that you must keep a high AA of equities approaching retirement, to offset inflation. Sure, I'll hold equities, but I'm not feeling the risk/reward with respect to inflation is as compelling right now as we've been told.

 

[Hal3]

I have almost no cash on hand in my investment accounts.

Against inflation: equities, TIPS, commodities (gold, silver, oil mostly), real estate

Against further weakness in the USD: foreign equities, foreign currencies.

I have almost no cash on hand in my investment accounts.

And I am all cash. And very concerned. We know inflation is coming. You can't print this much money and not have inflation. I just don't know how to escape it.

TIPS seems like the answer but 1. The Government games the inflation figures and 2. They don't protect you from interest rate risk.

Here is a recent TIPS auction:

20-YEAR TIPS 01-30-2009 01-15-2029 Interest rate 2.500% Yield 2.500% Price 99.063837 CUSIP 912810PZ5

How much would your investment in these be worth if three years down the road the Government is so desperate for cash that they are selling an equivalent bond with an interest rate of 10%?

Surprise, surprise!

For some reason I am not reassured by the thought of owning gold.

I just can't figure out a way to escape the coming inflation tax.

Any thoughts appreciated.

 

[Hal3]

TIPS and interest rate risk.

Here is a recent TIPS auction:

20-YEAR TIPS 01-30-2009 01-15-2029 Interest rate 2.500% Yield 2.500% Price 99.063837 CUSIP 912810PZ5

How much would your investment in these approximately $1000 face value bonds be worth three years down the road if the Government is so desperate for cash that they are selling an equivalent bond with an interest rate of 10% while claiming inflation is under control?

According to my calculations about $350.00 depending on how you reinvest the interest payments.

Is that correct?

Do you TIPS enthusiasts know the value of your TIPS bonds could drop to 35% of their present value in a not-too-unlikely scenario?

Am I correct here or did I miscalculate somewhere?

 

[Maurice]

A TIPS auction where the outcome is 10% over CPI - do you really consider that scenario to be not-too-unlikely? I have trouble envisioning it myself.

It seems to me that the not-too-unlikely scenario we need to hedge against is the one where the 10 yr (non-inflation protected) starts yielding 10% or higher. In that scenario I would think the government will have long since quit issuing TIPS. Or inflation will have driven the real return lower, not higher.


I'm just curious - in this scenario where a 20 year TIP is yielding 10% + CPI, what do you envision the interest rate on the 10 year bond to be?

 

[FIREd]

Why would you believe that real yields on TIPS would go up if inflation was a problem? We saw recently that, as deflation fears took over, people moved away from TIPS and drove real rates up. As inflation becomes a problem again, everyone and their neighbor will seek inflation protection with TIPS driving real rates down, and making older TIPS with higher real rates more valuable, not less.

In fact, as inflation picks up, the interest rate risk becomes a problem for plain vanilla treasury bonds, not TIPS. The government will have to raise interest rates on treasury bonds to make them more attractive (relative to TIPS), hence hurting the value of existing treasury bonds.

 

[Hal3]

TIPS

A TIPS auction where the outcome is 10% over CPI - do you really consider that scenario to be not-too-unlikely? I have trouble envisioning it myself.

I believe the Government fixes the Interest rate and the market determines the price. Here is how it would work: The government needs 47 Trillion dollars or some such ridiculous amount. So they sell TIPS. We get the TIPS. They get our cash. No one is buying any more. So they have to increase the interest rate on the bonds to pry the last few dollars out of our accounts. So, out comes a TIPS with a 10% stated rate. It goes for $1000 or thereabouts.

So you want to sell your old TIPS paying $25 (2.5%of $1000) per year for the next 17 years. How much is that worth when the Government is selling TIPS that pay $100 dollars per year for the next 17 years? The answer is about $350.

The interest rate on other bonds would be in the same market range plus a presumably higher risk premium - say 12% to 14% interest. Remember the Jimmy Carter years? I was holding on to some Ginnie Mae's at the time so I have experienced this first hand.

 

[ziggy29]

According to my calculations about $350.00 depending on how you reinvest the interest payments.

Is that correct?

Do you TIPS enthusiasts know the value of your TIPS bonds could drop to 35% of their present value in a not-too-unlikely scenario?

Am I correct here or did I miscalculate somewhere?

You didn't miscalculate but I think you made some almost impossible assumptions.

You ask what would happen if the Treasury was desperate enough that they had to start issuing bonds at 10%. Well, in reality, does anyone see this happening in the absence of high inflation? And if inflation is high, the nominal return of the TIPS will also be high.

You are trying to "what if" the price of TIPS using methodology that applied to fixed nominal-rate bonds. And since one of the main reasons that a traditional fixed-rate long bond gets killed is because of spiking interest rates probably fueled by high inflation, it's a mistake to try to assume TIPS would behave the same way.

Put another way: If your assumptions were correct, wouldn't TIPS prices have shot higher along with Treasuries as interest rates fell? Doesn't the fact that they didn't do that tell you that maybe, just maybe, TIPS and Treasuries respond differently to market conditions? The guarantee of a positive real return -- something Treasuries don't have -- protects TIPS from the same value erosion in an inflationary higher-rate environment.

 

[ziggy29]

I believe the Government fixes the Interest rate and the market determines the price. Here is how it would work: The government needs 47 Trillion dollars or some such ridiculous amount. So they sell TIPS. We get the TIPS. They get our cash. No one is buying any more. So they have to increase the interest rate on the bonds to pry the last few dollars out of our accounts. So, out comes a TIPS with a 10% stated rate. It goes for $1000 or thereabouts.

There is simply no way the Treasury will issue an inflation-protected bond with a guaranteed, REAL 10% return.

Nominal 10%, maybe, if inflation spikes again -- but REAL? No chance in hell. I don't consider your hypothetical to have the remotest chance of occurring. I think the supervolcano in Yellowstone has a better chance of going off.

 

[Hal3]

I'm not sure what you mean by "REAL". The only thing the will affect the price of a bond paying $25 per year is how much the bonds on the market are paying when you sell. Bonds paying $100 per year are by no means unheard of in recent financial history. It's the $100 per year that affects the price of your bond.

I think what you are implying is exactly what I am saying.

TIPS will protect you from inflation, hopefully. They do not protect you from changes in interest rates not attributed to inflation.

 

[Hal3]

There is also no need to become hostile. This is just mathematics. We are not accosting anyones DNA here.

 

[ziggy29]

I'm not sure what you mean by "REAL". The only thing the will affect the price of a bond paying $25 per year is how much the bonds on the market are paying when you sell. Bonds paying $100 per year are by no means unheard of in recent financial history. It's the $100 per year that affects the price of your bond.

I think what you are implying is exactly what I am saying.

TIPS will protect you from inflation, hopefully. They do not protect you from changes in interest rates not attributed to inflation.

And under what circumstances would TIPS ever provide a 10% coupon rate? The only possibility is credit risk, and if the Treasury's credit was ever so bad that it had to guarantee a 10% return over inflation, then we're all screwed anyway and pretty much any conventional security would be toast. We're talking about guns and ammo, living off-grid and growing all your own food here...

Under any halfway mainstream scenario where the Treasury remains one of the most trusted borrowers on the planet, there's no way we'll ever see 10% TIPS (and probably not even 5%) in our lifetimes.

 

[Hal3]

xkcd - A Webcomic - Duty Calls

 

[brewer12345]

Its worth remembering that within the last 18 months 5 year TIPS went to a negative real yield because people were panicked about getting inflation protection. So if inflation moves to the headlines again, I would expect TIPS to appreciate.

Personally, I am hedging inflation by large holdings in tangible asset owning companies. I may add some commodities or commodity producers as well.

 

[harley]

There is also no need to become hostile. This is just mathematics. We are not accosting anyones DNA here.

I just reread the thread. I don't see any hostility. A little incredulity, maybe. And a lot of disagreement. But no hostility. Unless disagreeing with you is being hostile.

 

[FIREd]

Interesting article:

Bloomberg.com: Worldwide

 

[REWahoo]

The subject of the article:

Feb. 2 (Bloomberg) -- For the first time since 2007, Treasury investors are betting that inflation will accelerate.

The yield on 10-year notes exceeds the consumer price index by 2.74 percentage points, the most since December 2006. The gap between two- and 10-year rates widened at the fastest pace in a year last month as traders demanded more compensation for longer-term debt. Treasury Inflation Protected Securities that signaled falling prices as recently as Nov. 20 show they will increase in the U.S. this year.

 

[charlie]

I purchased several inflation linked bonds and a large inflation linked CD a few years ago in my IRA. These instruments pay on a monthly basis about 2% + CPI. This worked out very well until very recently as inflation has become almost negative. Some of the bonds are now discounted quite a bit due to the low payout.

Although I am 74 and taking RMD (not in 2009 thank goodness) my IRA is liquid enough that I can hold out at least 3 years (including 2009) without being forced to sell any of the discounted bonds or equity.

The bottom line is that you should be careful about buying TIPS or CDIPS or inflation linked bonds if you depend on the payout for living expenses or the payment of your RMD.

Personally, I think that TIPS are a good buy right now if you don't need the income. Vanguard's TIPS fund is paying about 3% real right now.

IMHO, inflation is right around the corner ..... maybe as soon as late 2010, so TIPS and my inflation linked bonds will likely rise in value and my
IRA will be happy once again. In any case, I will hold them until I decide not to.

Cheers,

charlie

 

[ziggy29]

Treasury Inflation Protected Securities that signaled falling prices as recently as Nov. 20 show they will increase in the U.S. this year.

And I agree. What's the catalyst for lower prices? Does anyone really think energy prices will fall much more? Are most people seeing the cost of most of their goods and services going down or up?

Most prices are rising, and in the absence of plummeting oil prices -- combined with the government's determination to fend off deflation and shrinking money supply -- it seems hard not to bet on higher inflation in the long run.

 

[clifp]

I still have a decent chunk of Sallie Mae bonds OSM/ISM which despite all of the bad news still are sending me inflation adjusted checks every month.

I finally bought an Oil ETF which I think will act as an inflation hedge. Plus I like Ha Ha suggestion in another thread for timberland, in particular WY as good way of hedging against inflation.