Why not 100% TIPS for Bond portfolio?

[clifp]

If you ever got to a 4% real yield on a TIP you could set up your portfolio 100% TIPs with a 4% SWR and have zero worries....would never need to look at the market again (at least for the duration of the TIP).

I view a default on TIPs as being very close to an end of the world as we know it scenario.

Like so many investment principals this works better in theory than in practice. Back in 2000, shortly after retiring and learning about the 4% SWR. I put about 40% of my IRA in 10 year TIPS, with real yields between 3.8 and 3.96%. During the 2008 crash, when the prices of TIPs shot way up and stocks went way down. I sold the TIPs and bought corporate inflation protected bonds (ISM/OSM) and equities. I looked like an idiot for the first 6 months but 2.5 years later I think both trades worked out pretty good. If I had been more prudent I would have held the bonds to maturity. If I was depending on the bonds for income I would have suffered a tremendous hit to income with the yields dropping from just under 4% down to .75% for 10-year and ~1.75% for 30 year TIPs. I am pretty sure that I didn't have the option to purchase 30 Year TIPs bonds back in 2000, at least not through Schwab.

Second I think it is important to realize that CPI is a pretty crude measure, especially if you are putting 100% of your assets into TIPs. Now I am not one of those types that think that Uncle Sam is deliberating lying about measuring CPI. (Although I acknowledge they have an incentive to do so). Still I think there can be a significant difference between the governments CPI and your personal one. For instance when I was a working stiff in the 90s. Two of the fastest growing components in CPI, health care, and shelter were irrelevant to me. The company picked up the tab for medical insurance and my copays were small. I owed my own home and so housing pricing didn't impact me, plus I bought lot of electronic toys, all in all I bet my personal inflation rate was lower than the reported rate. Fast forward to the last few years, medical cost continue to increase rapidly, but the drop in housing prices and the rental equivalence measures, have put a drag on reported inflation rates. Once again I am not impacted by housing price changes, but since I now buy my own insurance with pretty bare bone coverage, and it is higher cause I am older, CPI dramatically understates my personal inflation rate. In fact the increase in medical cost alone for me the last two years were higher than the government reported CPI.

Now if you have reasonable percentage of your money in TIPs say 25% the difference between your personal CPI and the TIPs increase in payments probably don't matter much. However, if you are 100% dependent on TIPs, you could see a big decrease in your disposable income if there is a mismatch.

 

[mystang52]

Wow, lots of info to digest! My gut reaction, after reading these replies, is maybe TIPS (probably a fund, not individual bonds) has a place, but not 100% of the Bond portion. Thanks, all, for your input.

 

[veremchuka]

TIPS provide protection against every kind of inflation that is captured by CPI, unexpected or otherwise. It's a mechanical feature of the security. The principal balance is adjusted periodically based on changes to CPI.

I'm one who doesn't believe CPI is manipulated. If it were, you'd see credible economists adjusting their models to back out whatever they believed the government was doing wrong. You'd see the same discussion of adjustments every time the CPI was released. And if the index was bad enough, you'd see Wall Street firms publishing their own competing indexes. There are people in the private sector who have a lot of money at stake in getting this stuff right. Until you see them walking away from government statistics, I think you have to take the people casting stones who have nothing at stake with a grain of salt.

The other thing you'd see are inflation break-even spreads significantly higher than CPI readings. You don't see that. Which means that either the internet chatter boxes are wrong about CPI manipulation, or the market is stupid.

Thanks, I see that the CPI isn't as suspect as I feared it could be.

I would buy the TIPS fund not the individual bonds. Presently the fund's yield is zip tho TIPS have had a decent return YTD no doubts it's nav appreciation. I'd like to see the yield go up to send the nav down before I exchanged any roll over IRA funds into them vs buying them at an elevated nav.

I think TIPS would be a good thing for retirees but I am still a little conflicted about them. They always say to not invest in something you don't understand. While I understand how they protect against inflation, I don't fully grasp how they function. I've read explanations and follow it while reading it but I still don't know what to expect unlike I have a feel for this re equity and bond funds relative to the economy and market events. One day just not now.

 

[Gone4Good]

Presently the fund's yield is zip tho TIPS have had a decent return YTD no doubts it's nav appreciation.

I agree. I also feel this way about virtually every marketable security in the fixed income universe. CDs with low break-fees (like those offered by Alley) and online savings accounts make far more sense to me than any bond or bond fund at the moment.

 

[veremchuka]

Here's an interesting take on ST TIPS, not very good sounding!

tips-bonds-investment-marketwatch: Personal Finance News from Yahoo! Finance

 

[MichaelB]

The treasury market has an “implied inflation” component, which is the difference in YTM between a nominal treasury and TIP of the same maturity. Right now it is just under 2.5% average over 10 years.

If actual inflation, annualized over 10 years, is higher the TIP will provide a greater total return compared with the nominal 10 year bond.

TIPS are best when there is unexpected inflation. Here they outperform nominal treasuries and just about every other investment grade bond category. Conversely, they perform poorly compared with nominal treasuries when there is unexpected low inflation or deflation. In addition, TIPS mutual funds will lose value compared with individual TIPS whenever there is deflation.

Which is better depends mostly not on inflation but instead what is the purpose of the fixed income investment. Two very important questions are:

Does pension provide a substantial portion of your total income and is it indexed?
Do you need to protect the fixed income portion of your portfolio against loss of real value or loss of nominal value.

If the bond holdings are to fund future expenses and withdrawals will be regular and predictable, buying and holding individual TIPS scheduled to mature when needed can be a good idean’t a bad idea. TIPS are easy to buy.

If the purpose of the fixed income is to have a component of portfolio safety – guaranteed funds available when needed to fund consumption or rebalance a portfolio, short term nominal treasuries may be more appropriate. This is because, unlike all other bonds, they don’t decline in nominal value. Historically they have tracked inflation quite well.

If you have a large indexed pension, you probably need little fixed income. If you have a pension with no cola, TIPs might not be enough, and you might want to protect your purchasing power with a combination of equities and commodities. If you have no pension, you might want some of both, so you have cash to rebalance and purchasing power for future purchases.

Here’s a link to a article on the Fido website, written based on Ibbotson research. https://guidance.fidelity.com/viewpoints/inflation-vs-deflation I have seen this (TIPS and ST treasuries comparisons) most commonly mentioned in research on asset allocation and commodities investments.

 

[Free To Canoe]

Here's an interesting take on ST TIPS, not very good sounding!

tips-bonds-investment-marketwatch: Personal Finance News from Yahoo! Finance

Same article as in post #16. Interesting how the same author is posting on different site formats.

100% TIPS right now (always good to look at extreme examples)? Nah.
A portion of your cash position in TIPS to hedge against the upcoming inflation?
Surely.

 

[Chuckanut]

TIPS bond funds have taken a beating lately. I am wondering if they are now a better value than a total bond index fund. The contrarian in me is starting to sniff an opportunity.

 

[mathjak107]

TIPS have done poorly . but the biggest risk of 100% tips is while they are linked to a cost of living index it isn't your personal cost of living index .

the cpi index's are only price change index'son a basket of stuff .

some items may be important to you and others not .

it is not an actual cost of living index and can be way different from what you experience as a personal cost of living change .you may come up way short of your actual needs .

 

[audreyh1]

The problem with TIPs is that they are long bonds.

 

[Willers]

If you are interested in learning more about them (specifically new auctions), I've found the insights on this site to be very useful. It is one opinion, but it helps explain the relative valuation of the offerings.

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