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Re: TIPS funds and deflation
Old 12-13-2006, 08:46 PM   #21
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Re: TIPS funds and deflation

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Originally Posted by Rich_in_Tampa
Thanks, Mickeyd. My understanding of TIPs was naive, it appears. I thought of them as inflation protection at the cost of decreased returns compared to similar FI of similar maturity.

While that's not entirely off-base, the benefits of additional diversification and returns that have an upside potential, too, make them more attractive.
Rich,

I think whether TIPS return more or less than similar maturity bonds depends on the actual rate of inflation versus expected inflation [see pg 5 of the ibbotson paper]. Hence, owning both TIPS and nominal bonds hedges your bets either way. Someone posted some returns for TIPS and nominal bonds in the UK from 1981-2000 over the VD board. It looks like in the 80-90's in the UK, TIPS did not return very much. Perhaps this was due to inflation expectations [from the 70's] being higher than real inflation. Also interesting is that post 2000, things flip-flopped, with TIPS beating nominal bonds.

Since TIPS have been around since about 1997 in the US, and TIAA-CREF has had a TIPS fund since 4/1997 we can do the correlation matrix for a bunch of their accounts [from 4/1997 to 8/2006]:

CREF Inflation linked bond
CREF Bond Market
CREF Equity Index
CREF Money Market
30 day Tbills [courtesy of Ken french]
CPI

CREFbond CREFequi CREFinfb CREFmony Tbills CPI
CREFbond 1
CREFequi -0.136042 1
CREFinfb 0.765623 -0.190142 1
CREFmony 0.169195 0.025680 -0.007228 1
Tbills 0.144833 0.013781 -0.020410 0.981431 1
CPI -0.093373 -0.116935 0.048917 0.001293 0.024667 1

Which is what the Ibbotson paper found [from 1970 - 1998]. TIPS had lower correlation to equites than nominal bonds, albeit slightly.

Anyway, if anyone wants to run efficient frontiers, I've got the monthly returns [nominal and real]. Looks to me like most of the efficient portfolios included both TIPS and nominal bonds.

fyi - here are three more academic papers on diversification with TIPS.

- Alec
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Re: TIPS funds and deflation
Old 12-13-2006, 10:09 PM   #22
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Re: TIPS funds and deflation

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Originally Posted by ats5g
I think whether TIPS return more or less than similar maturity bonds depends on the actual rate of inflation versus expected inflation [see pg 5 of the ibbotson paper]. Hence, owning both TIPS and nominal bonds hedges your bets either way.

Thinking about a little bit of TIPS in my "near cash" bucket (tax deferred), then dipping in when they do well, and essentially rebalancing every year or two. If nothing else, it would buy me time during an inflationary spell for things to settle down.
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Re: TIPS funds and deflation
Old 12-15-2006, 11:44 AM   #23
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Re: TIPS funds and deflation

I'd like to see an updated study using real numbers over the period 1997-2005. I think it would show they have underperfomed over that time frame.

However, they will probably look better as time smooths out the Fed's actions from 2000-2003...........
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Re: TIPS funds and deflation
Old 12-16-2006, 08:23 PM   #24
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Re: TIPS funds and deflation

I've been slowly reallocating our funds now that we have almost everything at Vanguard. I was planning a 10% allocation to TIPS in a 50/50 portfolio. When we had our financial plan done by Vanguard, then did not suggest any TIPS. I questioned the planner, but I wasn't satisfied with his answer - actually, he didn't really give me an answer, just that they don't think they are a good investment at this time. Is 10% too high an allocation?
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Re: TIPS funds and deflation
Old 12-17-2006, 06:25 AM   #25
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Re: TIPS funds and deflation

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Originally Posted by AlmostDone
I've been slowly reallocating our funds now that we have almost everything at Vanguard. I was planning a 10% allocation to TIPS in a 50/50 portfolio. When we had our financial plan done by Vanguard, then did not suggest any TIPS. I questioned the planner, but I wasn't satisfied with his answer - actually, he didn't really give me an answer, just that they don't think they are a good investment at this time. Is 10% too high an allocation?
I doubt it............10% of your money tracking the inflation index isn't a bad thing..........
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Re: TIPS funds and deflation
Old 12-17-2006, 02:50 PM   #26
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Re: TIPS funds and deflation

Quote:
Originally Posted by FinanceDude
I'd like to see an updated study using real numbers over the period 1997-2005. I think it would show they have underperfomed over that time frame.

However, they will probably look better as time smooths out the Fed's actions from 2000-2003...........
Looks like over 4/97-8/06, TIPS beat similar duration treasuries, but not by that much.

CREF Infl Linked Bond 6.83%
Vanguard Int Term Treas [VFITX] 6.55%

- Alec
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Re: TIPS funds and deflation
Old 12-18-2006, 06:06 PM   #27
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Re: TIPS funds and deflation

Quote:
Originally Posted by AlmostDone
I've been slowly reallocating our funds now that we have almost everything at Vanguard. I was planning a 10% allocation to TIPS in a 50/50 portfolio. When we had our financial plan done by Vanguard, then did not suggest any TIPS. I questioned the planner, but I wasn't satisfied with his answer - actually, he didn't really give me an answer, just that they don't think they are a good investment at this time. Is 10% too high an allocation?
I don't think 10% is too high. In fact, I'd personally go as high as 50% of my fixed income portfolio in TIPS. Why so high? The yield of every bond is made up of two components. One is an inflation expectation and the other is a real return expectation. With regular fixed coupon bonds, both return attributes are based on market assumptions. The only thing we know today with certainty is that current market assumptions about the future will be wrong. They might be a little wrong, or they might flat out poop the bed.

With regular bonds, I'm betting that actual future inflation will be lower than current market expectations. With TIPS I'm betting the exact opposite (that inflation will be higher). Because I have no clue what inflation will be over the next 20 years (and because no one else does either), it makes perfect sense for me to hedge my bets between the two possible scenarios.

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