The current long thread here on this being a "golden age" for fixed income investing inspired me to share this even longer thread on Bogleheads:
https://www.bogleheads.org/forum/viewtopic.php?t=382830
There's no need to read all 540 posts (!) and counting in the thread, as the main points are made in the OP's initial post:
"An aspect of the nominal bond vs. TIPS issue that is often overlooked is the asymmetric risk investors are exposed to with nominal bonds like TBM. Note that this assumes both that an investor's future spending and other liabilities will be in at least roughly real (i.e., inflation-adjusted) dollars and that the CPI used to derive TIPS' yields is a reasonably good measure of inflation. In general, these seem to be fairly reasonable assumptions, and I ask that we do not derail this discussion on questioning them as this is apt to get the thread locked.
My contention that there is asymmetric risk in the decision to allocate one's fixed income in nominal bonds, such as TBM, or inflation-linked bonds, such as TIPS.
With individual TIPS held to maturity, their real return known with precision at the time of purchase. There is no risk to the future buying power of TIPS given the stated assumptions in the first paragraph.
But with nominal Treasuries, their real return unknown with precision at the time of purchase. Only their nominal starting yield is known. They are completely exposed to the risk of unexpected inflation, which has historically been the single biggest risk to fixed income holdings.
Therefore, absent deflation, it is indisputable that nominal Treasuries are riskier than TIPS when it comes to funding future consumption in real dollars. But there's another way to consider this that further demonstrates the same point.
If we assume that inflation is highly unlikely to average below 0% over a given decade, we can assume then that the best possible real returns of 10 year nominal Treasuries is their starting nominal yield of 2.65%. But there is no limit to how low the real returns of 10 year nominal Treasuries can be. In other words, 10 year Treasuries have very long left-tail risk. With TIPS held to maturity, their real return is, again, known with precision at the time of purchase."
There's much more to it of course and as you might expect there's much discussion in subsequent posts of the few situations where nominal bonds might do better (deflation especially) and many other such topics.
I'm sharing this here because for retirees especially the importance of having assets that provide reliable, predictable income to meet essential needs can hardly be overstated. Folks like Zvi Bodie and William Bernstein have been emphasizing TIPS for years but mainstream brokerages continue to push Total Bond Market and other such inferior options. Interestingly one of the reasons for this (discussed well into the mega-thread) is that the TIPS market is too small to be of any use to these giant firms in their target retirement date funds, which are a huge part of their business. And among the major firms only DFA offers a liability-matching retirement income fund comprised mostly of TIPS.
https://www.bogleheads.org/forum/viewtopic.php?t=382830
There's no need to read all 540 posts (!) and counting in the thread, as the main points are made in the OP's initial post:
"An aspect of the nominal bond vs. TIPS issue that is often overlooked is the asymmetric risk investors are exposed to with nominal bonds like TBM. Note that this assumes both that an investor's future spending and other liabilities will be in at least roughly real (i.e., inflation-adjusted) dollars and that the CPI used to derive TIPS' yields is a reasonably good measure of inflation. In general, these seem to be fairly reasonable assumptions, and I ask that we do not derail this discussion on questioning them as this is apt to get the thread locked.
My contention that there is asymmetric risk in the decision to allocate one's fixed income in nominal bonds, such as TBM, or inflation-linked bonds, such as TIPS.
With individual TIPS held to maturity, their real return known with precision at the time of purchase. There is no risk to the future buying power of TIPS given the stated assumptions in the first paragraph.
But with nominal Treasuries, their real return unknown with precision at the time of purchase. Only their nominal starting yield is known. They are completely exposed to the risk of unexpected inflation, which has historically been the single biggest risk to fixed income holdings.
Therefore, absent deflation, it is indisputable that nominal Treasuries are riskier than TIPS when it comes to funding future consumption in real dollars. But there's another way to consider this that further demonstrates the same point.
If we assume that inflation is highly unlikely to average below 0% over a given decade, we can assume then that the best possible real returns of 10 year nominal Treasuries is their starting nominal yield of 2.65%. But there is no limit to how low the real returns of 10 year nominal Treasuries can be. In other words, 10 year Treasuries have very long left-tail risk. With TIPS held to maturity, their real return is, again, known with precision at the time of purchase."
There's much more to it of course and as you might expect there's much discussion in subsequent posts of the few situations where nominal bonds might do better (deflation especially) and many other such topics.
I'm sharing this here because for retirees especially the importance of having assets that provide reliable, predictable income to meet essential needs can hardly be overstated. Folks like Zvi Bodie and William Bernstein have been emphasizing TIPS for years but mainstream brokerages continue to push Total Bond Market and other such inferior options. Interestingly one of the reasons for this (discussed well into the mega-thread) is that the TIPS market is too small to be of any use to these giant firms in their target retirement date funds, which are a huge part of their business. And among the major firms only DFA offers a liability-matching retirement income fund comprised mostly of TIPS.
