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Inflation & AA?
Old 01-08-2008, 11:14 AM   #1
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Inflation & AA?

I am growing concerned about possible future inflation. It looks like the powers that be will do whatever it takes to try to ward off a possible recession regardless of the effects on the future economy.

Most of the AAs that I have followed do not seem to have much to counteract inflation. (some have TIPS but I'm not sure they are much of a buy currently)

Does your AA contain an inflation hedge? If so what and what percentage?
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Old 01-08-2008, 03:06 PM   #2
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So far only equities and TIPS/cpi indexed securities are shown to outpace the CPI.

TIPS are a lousy buy right now.
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Old 01-08-2008, 06:15 PM   #3
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TIPS are a lousy buy right now.
I agree but I'm not selling what I have. Unless someone can convince me there is a better alternative.
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Old 01-08-2008, 07:19 PM   #4
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The price of safety [i.e. treasury yields] and inflation protection [i.e. TIPS yields] is higher [i.e. lower yields] than it has been. However, that doesn't necessarily mean that TIPS are a "bad buy." I suppose it depends somewhat on how much inflation risk you're exposed to. For example, Nords has a COLA'd pension, and isn't at much inflation risk, so he'd probably rather buy CD's than TIPS. But someone with a fixed pension might still find TIPS attractive now, especially with only a 2-3% yield spread between TIPS and similar maturity nominal treasuries.

Theory time - like TIPS, ST bonds are also slighly positively correlated with inflation, and should be a good hedge against inflation. I think the first bond fund that Fama helped develop for DFA was called the "Inflation Hedge Fund", which was composed of ST bonds, and is now DFIHX.

Full Disclosure now : I'm still in the accumulation phase [age 32], and would like to only use TIPS as my fixed income, but 401(k) restrictions limit me to VBMFX [oh darn ].

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Old 01-08-2008, 07:34 PM   #5
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What commodity prices are inflating the most? Oil? Food? Real Estate? Healthcare?

Buy into those sectors and ride it up? My commodity futures fund is doing pretty well so far. I just wish I understood better how it operates. :confused:
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Old 01-08-2008, 07:56 PM   #6
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For commodities I've added DBC to my mix and will add some DBA yet this year and as previously mentioned keeping the bond maturities short. Bonds longer than 5yrs is the investment that scares me the most.
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Old 01-08-2008, 07:56 PM   #7
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Mr Adam Smith's Invisible Hand and Mr Market this time around - via Target Retirement - might want to add a tad/just a tad mind you to the Norwegian widow's stash of individual stock via psssst Wellesley to put my thumb on the scale(after a brain phart). I didn't lose my shirt but I didn't get rich either the last go round(70's/80's) - gold , silver, platinum coins, timberland, rental RE,REITs, foreign bond CEF, Vanguard Trustee's co-mingled International and pssst Wellesley.

If I remember some of the old cliche's - going international helps smooth inflation rates/reflected via world currencies relative giggling and growth stocks can price in inflation(already priced in) so when value gets dumped and lies bleeding on the pavement - you dollar cost average in those that are still wiggling and may recover - hence pssst Wellesley.

Freeze dryed food, collectible scotch, wine, guns and commodities are out. Will I ever crack and dabble a little in CCF's via the PCRIX crowd. I don't think so - but never say never.

heh heh heh - some of those old coins sure look purty in the deposit box - but only a few left. Target Retirement 2015 and a few items as a hobby to B.S. about pontificatingly speaking.
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Old 01-08-2008, 08:20 PM   #8
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heh heh heh - some of those old coins sure look purty in the deposit box - but only a few left. Target Retirement 2015 and a few items as a hobby to B.S. about pontificatingly speaking.
I still have a 1980 Canadian Maple Leaf bought at around $800 back then. Kept it to remind me of a stupid foray into a stupid investment. TIPS purchased at yields above 2.3% are an inflation hedge I can understand.

Here is a link to an article by Bill Gross from August 2003 that discusses TIPS: PIMCO Bonds - IO August 2003
The charts on real interest rates are something to keep in mind.
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Old 01-09-2008, 09:40 AM   #9
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I still have a 1980 Canadian Maple Leaf bought at around $800 back then. Kept it to remind me of a stupid foray into a stupid investment. TIPS purchased at yields above 2.3% are an inflation hedge I can understand.

Here is a link to an article by Bill Gross from August 2003 that discusses TIPS: PIMCO Bonds - IO August 2003
The charts on real interest rates are something to keep in mind.
OK Isbcal, I read it. As always Bill Gross's folksy style is entertaining but makes a difficult subject more difficult for me to decode the real message. That was in 2003, at the bottom for stocks as it turned out. The return from equities since then would have beat TIPS by a mile. And now, at least from what I've read in the last few months, TIPS as not as good a bargain. I'd like to see Bill's current assessment for TIPS. Has he put one out lately? And what would constitute a BUY position for TIPS in the future? I concur that MM is not a good place to have your cash at the moment for the same reasons he gave in 2003 (plus the additional banking problems at the moment), but where is a good place?
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Old 01-09-2008, 10:35 AM   #10
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I didn't mean one should buy TIPS now and I certainly do not mean they are an equity substitute. TIPS are negatively correlated to equities so they belong in your fixed income investments. Currently 10yr TIPS are too low for me to buy, TIPS are at 1.53% now but in July 2007 they were at 2.7%. I personally have only bought when TIPS were above 2.4%. Larry Swedroe has suggested a purchase method in his bond book (see Appendix B).

I think the Gross article is good for it's discussion of focusing on your total real return in fixed income investments. The graphs in that paper are worth remembering for the future. With all the rates pretty low by historical standards I don't know where I'd put money from a MM fund. We could be stuck with low rates for a long time. At least Vanguard Prime MM is at 4.55% right now but that may not last.
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Old 01-09-2008, 09:30 PM   #11
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What if you suspect the government's stated CPI figures are cooked? Are TIPs a path to a slow(or not so slow) bleed of portfolio value? I am pretty worried about inflation. I have little confidence the government will not sucumb to the temptation to inflate ourselves out of current uncomfortable extigencies.

Should I buy Swiss Franks?
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Old 01-09-2008, 10:14 PM   #12
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What if you suspect the government's stated CPI figures are cooked? Are TIPs a path to a slow(or not so slow) bleed of portfolio value? I am pretty worried about inflation. I have little confidence the government will not sucumb to the temptation to inflate ourselves out of current uncomfortable extigencies.

Should I buy Swiss Franks?
Obviously since I purchased TIPS I'm not worried about the CPI being too far off of reality. Personally I just want to protect against inflation as stated by the CPI. Memories of the 1970's type inflation are too fresh to suggest a repeat IMO.

Swiss Franks ... perhaps you know more then the currency markets? Be my guest .
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Old 01-10-2008, 07:58 AM   #13
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What if you suspect the government's stated CPI figures are cooked? Are TIPs a path to a slow(or not so slow) bleed of portfolio value? I am pretty worried about inflation. I have little confidence the government will not sucumb to the temptation to inflate ourselves out of current uncomfortable extigencies.

Should I buy Swiss Franks?
IMO, the way the gov't calculates the CPI-U is pretty transparent, and since the market [not the gov't] determines the real rates of TIPS at auctions and daily, any "cooking of the numbers" by the gov't is probably taken into account.

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Old 01-10-2008, 08:27 AM   #14
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The best time to buy inflation protected securities is when no one is afraid of inflation.
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Old 01-10-2008, 08:30 AM   #15
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The best time to buy inflation protected securities is when no one is afraid of inflation.
Brilliant. The converse is of course, the time to buy deflation protection is when no one is afraid of deflation.
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Old 01-10-2008, 09:09 AM   #16
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IMO, the way the gov't calculates the CPI-U is pretty transparent, and since the market [not the gov't] determines the real rates of TIPS at auctions and daily, any "cooking of the numbers" by the gov't is probably taken into account.
Agreed. The question is "yahbut, does the CPI-U relate to inflation as experienced by an early retiree".

But while we're on the subject of transparency, can you explain in laymans terms how the CPI-U incorporates changes in health care costs?
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Old 01-10-2008, 10:34 AM   #17
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CFB - here is a link to a BLS source: How BLS Measures Price Change for Medical Care Services in the Consumer Price Index

I should add another link to a pdf from BLS:
Experimental Consumer Price Index for Americans 62 Years of Age and Older, 1998-2005
http://stats.bls.gov/cpi/cpiexpcpie2005.pdf

Here is another short paper on why published averages don't match an individual's CPI:
The Consumer Price Index--Why the Published Averages Don't Always Match An Individual's Inflation Experience
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Old 01-10-2008, 11:08 AM   #18
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Eh, I should have led with the image below.

My point with regards to transparency is that...yes...its well documented. Now...can you explain it?

I'm also well aware of the fact that the CPI doesnt match up well with an individuals experienced inflation. I'd further argue that it matches up pretty dang horribly with an early retirees budget demands, especially in the area of healthcare. Yet so many people expect a cpi adjusted product to protect them from the effects of inflation in retirement.

The catch all is to say "well, I just want to be protected from the stated CPI inflation."

Why does that do you any good when health care costs have doubled and tripled over the last 5-10 years and the CPI reflects almost none of that, but the cost of dining out and gas for commuting are well reflected, when those activities often drop off after retirement?

TIPS at 2.75+% start to make some sense as fixed income investments. Start. TIPS at 1.5%-2% dont.
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Old 01-10-2008, 11:40 AM   #19
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Why does that do you any good when health care costs have doubled and tripled over the last 5-10 years and the CPI reflects almost none of that, but the cost of dining out and gas for commuting are well reflected, when those activities often drop off after retirement?
Isn't the solution obvious? You just eat out a lot and don't go to the doc!

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TIPS at 2.75+% start to make some sense as fixed income investments. Start. TIPS at 1.5%-2% dont.
So CFB, what fixed income investments do you favor? Or did you load up on TIPS last July?
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Old 01-10-2008, 02:00 PM   #20
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CFB,

If you feel that the CPI-U doesn't reflect at the increase/decrease in your cost of living, and that yours is higher, so be it. According to the above link, the CPI-U kept up pretty well with the CPI-E. 22% vs. 24% from 12/97-12/05. Also, given that things like FIREcalc use the CPI-U in their modeling, perhaps people whose costs of living increase greater than the CPI-U should be withdrawing less than what FIREcalc shows as a possible SWR.

However, I'm not sure that all this means that you and/or retirees should avoid TIPS, as they are the only asset I know of that is specifically linked to any measure of inflation besides college savings plans like CollegeSure CD's or PrePaid Tuition plans.

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TIPS at 2.75+% start to make some sense as fixed income investments. Start. TIPS at 1.5%-2% dont.
Again, I think that depends on how much inflation risk a person is exposed to. Using my prior example, Nords probably wouldn't be attracted to TIPS unless they were closer to 3-4% real yields given his [fairly large ?] COLA'd pension. Do nominal fixed income rates have an expected inflation premium built in? Yes. But they don't protect against unexpected inflation, a retirees nightmare, which TIPS do.

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