I have 2 years of spending money. Could TIPS drop more than the Short-Term Bond Index Inv? Would 40% in TIPS be to much? I like thier track record.
Yes, TIPS [longer than 5 years, VIPSX and other TIPS funds] could drop in value more than the ST bond index and other ST bonds/funds. Likewise TIPS could increase in value more than the ST bond index and other ST bonds/funds. However, remember that it's the
total portfolio volatility that's important, not necessarily the volatility of the
individual funds, and how those funds perform at different times.
For example, even though a TIPS fund was more volatile than VFSTX or VBISX from 1998 through June of this year, when combined with the TSM and Tot int'l funds, the portfolio with 40% TIPS was less volatile than the portfolio with 40% VFSTX or 40% VBISX. [I just went back to 1998 b/c that's when the first whole year of CREF's ILB bond acct was live]
It's really tough to say right now how much TIPS one should have. It depends on a whole host of factors, but I'll try and offer my opinions.
How much are you willing to pay for inflation insurance? Like other forms of insurance, if you cannot self-insure, you pay a premium by using TIPS over nominal treasuries/bonds. And you also accept a lower
"expected" return. You pass off the inflation risk to the issuer of the TIPS [or Treasury]. However, like other forms of insurance, when the thing you paid the premium for [inflation] is rearing its ugly head, the TIPS should pay off. Meaning that the TIPS should do better than nominal bonds exactly when you need them to. Note I said should. TIPS and inflation linked bonds only started in the 1980's [in the UK] and in the 1990's in Canada + US.
Like life, home, renter's, car, fire, etc. insurance, there's no way to know if the inflation insurance TIPS offer will pay off. The whole point of the insurance is that it pays off when you need it.
In conclusion, owning some TIPS is probably a good idea. Now, just to hedge your bets, and realizing that the future is totally unpredictable, it would probably be better to go with some mix of TIPS and nominal bonds [like CDs or VBISX] so your covered either way. If inflation turns out to be a problem, you didn't have every bond in TIPS. But if inflation turns out to be a problem, you've got some money in TIPS. Whatever you're comfortable with here. For example, 1/2 of the bond money in TIPS, etc. The most important thing is that you're able to stick with a strategy when it starts to get tested. For example, in 2005+2006 TIPS were sucking wind compared to other bonds.
- Alec
