TIPS/Bonds and Cash

[viking111]

Hello all. Hope all is well.

How many people hold tips as a large part of their portfolio and use it for example the first 10 to 12 years of their retirement while allowing the rest of their portfolio to grow at an AA of around 60/40.

Also, would you hold the 40 bonds in intermediate treasury or total bond market?

 

[pb4uski]

I know OldShooter is into TIPS... and perhaps a couple other posters.

I'm not keen on bond funds or ETFs because of their interest rate risk... I prefer CDs... but I concede in the long haul either intermediate treasury or total bond would be ok.

 

[MichaelB]

No TIPs for me, as my portfolio is all taxable and TIPs are tax inefficient. Most of our fixed income is in an intermediate term muni bond fund. If I had a large tax deferred account I would consider a ladder of TIPs covering 10 years or so.

I'm not keen on bond funds or ETFs because of their interest rate risk... I prefer CDs... but I concede in the long haul either intermediate treasury or total bond would be ok.

For some reason I thought you had a ladder built of fixed term bond ETFs.

 

[OldShooter]

Hello all. Hope all is well.

How many people hold tips as a large part of their portfolio and use it for example the first 10 to 12 years of their retirement while allowing the rest of their portfolio to grow at an AA of around 60/40.

Also, would you hold the 40 bonds in intermediate treasury or total bond market?

I'm not sure I understand your question but I can tell you the short version of our TIPS story.

When DW retired in late 2006 we looked ahead and concluded that the only serious risk to our retirement was high inflation. This in memory of 1970s/1980s. So we made quite a large buy of TIPS; the 2s of 2026 to be exact. These are held in IRAs so the tax issues are not there for us.

We view the TIPS as long-range insurance -- certainly not something to be cashed right away. Once bought we basically ignored them for quite a few years. When interest rates flatlined, we ended up looking like genius's, with the TIPS value going to about 150% of face. Just lucky,though. We have sold off some along the way, our excuse being that our planning horizon moves in by a year every year so our need for inflation insurance is lessened. At 73YO we still hold more than half of them.

We do count them in our AA, as we do all financial assets.

TIPS are easy to buy IMO because there is no real yield curve to worry about. The yield curve mostly prices inflation risk, which is zero for TIPS of course. That's why we just bought the longest, lowest coupon TIPS that were available at the time. We see no reason to even consider TIPS bond funds.

A couple of wrinkles: 1) TIPS end up paying approximately the calculated YTM at purchase plus actual inflation. Assuming even a conservative inflation expectation this may well make them the best yielding govvies out there. 2) TIPS face values adjust in January and July, with the amount of the adjustment known six months ahead of time. This makes for some goofy pricing for short duration TIPS -- I have just stayed away from it rather than try to outsmart the professionals.

 

[pb4uski]

... For some reason I thought you had a ladder built of fixed term bond ETFs.

No, no ladder... but a few years ago I was bullish on fixed maturity bond ETFs like Bulletshares... they are basically a proportional interest in a portfolio of bonds that mature in a given year.

 

[pb4uski]

....A couple of wrinkles: 1) TIPS end up paying approximately the calculated YTM at purchase plus actual inflation. Assuming even a conservative inflation expectation this may well make them the best yielding govvies out there. ...

But I seem to recall that current long-term TIPS pricing effectively locks in a negative real return... is that correct?

 

[Out-to-Lunch]

But I seem to recall that current long-term TIPS pricing effectively locks in a negative real return... is that correct?

That is correct: https://www.wsj.com/market-data/bonds/tips

But not sure what your point is? We expect Treasuries* to deliver a negative real return, too. They will only do better if inflation plummets. Are you just concerned about the "locking in" vs. "so you are telling met that there is a chance" aspect?

*Choosing Treasuries to have other aspects of the bonds to be similar, i.e., risk-free as best as we know it.

 

[big-papa]

Hello all. Hope all is well.

How many people hold tips as a large part of their portfolio and use it for example the first 10 to 12 years of their retirement while allowing the rest of their portfolio to grow at an AA of around 60/40.

Also, would you hold the 40 bonds in intermediate treasury or total bond market?

I hold a 60/40 allocation of stocks/nominal treasuries. But to the side I hold a TIPs (held in an IRA, synthesized with ETFs) + Ibonds (held at Treasury Direct) ladder as an inflation adjusted supplement to SS, which I plan to tap starting at age 70, and set up to last for 15 years. If still kicking around, will consider a SPIA around the end of that time. While probably not necessary, it helps with the sleep-at-night factor knowing that SS + this ladder will likely cover minimal living needs.

Is it part of my AA? It isn't targeted to be a certain percentage of my portfolio. Instead it's targeted to create a certain inflation adjusted income stream for a certain amount of time. I'll never rebalance into it or out of it - I'll only withdraw from it. And I won't adjust the 60/40 holdings because of it, either.

Still, if I do the calculation, this puts me overall at 55/45 today. In the long term, assuming stocks outpace bonds of all types and knowing I'll be withdrawing from the ladder someday, my overall mix will approach 60/40 over time. So close to being in the noise one way or another from a stock/bond mix.

Cheers

 

[big-papa]

When DW retired in late 2006 we looked ahead and concluded that the only serious risk to our retirement was high inflation. This in memory of 1970s/1980s.

Yup - for a lot of us the memories of the 70s/80s, for better or worse, lead us towards holding some inflation protected assets...

 

[Markola]

One doesn’t only have opportunities to address possible inflation through asset allocation.

The famous early FIRE book “Your Money or Your Life” introduced me to the toolkit at hand to manage one’s “personal inflation rate,” meaning thinking about the large portion of one’s expenses that can be shielded from rampant inflation.

The majority can be shielded with intention and flexibility. For example, your housing expense won’t inflate if it is paid off or if you have a fixed rate mortgage. If certain groceries or clothes inflate, substitute different ones or shop somewhere else. If oil prices should explode, now we have electric vehicles and hybrids, etc., etc.

When I examine our many budget line items for the most dangerous exposure to inflation, healthcare is the most uncontrollable one. Still, it is only a portion of the overall, and we’ll start getting some assistance with it from Medicare in 7 years in our case.

 

[pb4uski]

That is correct: https://www.wsj.com/market-data/bonds/tips

But not sure what your point is? We expect Treasuries* to deliver a negative real return, too. They will only do better if inflation plummets. Are you just concerned about the "locking in" vs. "so you are telling met that there is a chance" aspect?

*Choosing Treasuries to have other aspects of the bonds to be similar, i.e., risk-free as best as we know it.

I wouldn't agree that one should expect Treasuries to deliver a negative real return too... though with what the Fed is doing that may well be the outcome.

The point is that in theory real government bond yields should not be negative since the base component for goernment bond yields is expected inflation... at least in 'normal" times whatever that is.

TIPs provide more surety that what you will receive will be close to inflation, but at current pricing is also sure to be negative on a real basis.

Decomposing government bond yields
“A nominal bond yield can be decomposed into four components: expected real rate, real term premium, expected inflation, and inflation risk premium. This decomposition has become an accepted practice for measuring the effects of monetary policy.”

“The expected real rate is basically influenced by monetary policy, i.e., both the current policy stance and market participants’ view of how the policy will evolve… The real term premium generally reflects the real-term interest-rate risk – a wide variety of risks other than inflation risks – as well as investors’ preference for safe assets and various other factors including the central banks’ policy actions…We define the inflation components as the difference between the nominal and real yields.”

Source:https://www.sr-sv.com/the-four-comp...nd yield can,the effects of monetary policy.”

 

[OldShooter]

But I seem to recall that current long-term TIPS pricing effectively locks in a negative real return... is that correct?

Well, check with your friendly neighborhood CPA, but I think this is the picture on real returns:

Govvies real return is: YTM at the time of purchase minus the inflation during the period.
TIPS real return is: YTM at the time of purchase.

So the spread between those two YTM numbers must be some kind of market consensus on expected inflation rates maybe with some risk premium one way or the other. As time passes, to the extent that inflation climbs and perhaps crosses the spread, the TIPS becomes more and more attractive. Whether the final return number is positive or negative really doesn't matter except politically. I am frankly surprised by all the angst people have about negative interest rates. No fun, certainly, but lots of things in nature are no fun and few if any are under our control.

That said, I do not see our TIPS as being in any kind of basis-point horse race. We own them as insurance against the possible day that inflation blows far past the small spreads we see in the current market. Further, I am not rooting for inflation any more than I am rooting for my house to burn down because I have insurance.

 

[OldShooter]

... “personal inflation rate,” meaning thinking about the large portion of one’s expenses that can be shielded from rampant inflation. The majority can be shielded with intention and flexibility. ...

I am not so optimistic. US inflation will almost certainly be either due to or a cause of the dollar declining in value. A significant decline, say, 20%, will result in a 25% increase in the landed dollar cost of all imports. That cost will be absorbed by the economy, probably mostly by consumers.

What will get hit? First, anything traded on world markets. Oil certainly, consequently plastics and other oil-derived chemicals. Food? Of course; meat (pork, chickens, ...) and animal feed (soybeans, maize aka corn, wheat, ...) Clothing. Consumer electronics. Metals (aluminum, steel, copper, ...) Substitution sounds good but IMO there won't be many places to hide.

Our houses? No place to hide there either. As values rise, the tax collectors will be along to extract the dollars they need to operate. Natural gas and electricity cost derive from international prices. Even water will rise as the water utilities try to recover their increased costs. Same-o for the wind and solar farmers.

Businesses will absorb some of the costs but guess who owns the business? We do, through our investments, public, and private pension assets, etc. People talk about businesses like they are bears in caves sitting on piles of money. Excusing for a moment executive salaries, there are no caves, no bears, and no piles of money. It is just us, the citizens, who eventually benefit from the business wins and suffer from the losses.

So ... IMO, really no place to hide "the majority" of our costs from high inflation.

 

[Out-to-Lunch]

I wouldn't agree that one should expect Treasuries to deliver a negative real return too... though with what the Fed is doing that may well be the outcome.

Hmmm, I must admit that I did not look up the current yields of nominal Treasuries when I posted that. But, looking this morning, a 3-year Treasury is paying 0.19%. I suppose it is possible, but I really expect inflation to be more than 0.2% p.a. over the next 3 years. Don't you? (But I fully admit that it could turn out differently, but I expect it to be higher.)

The point is that in theory real government bond yields should not be negative since the base component for goernment bond yields is expected inflation... at least in 'normal" times whatever that is.

TIPs provide more surety that what you will receive will be close to inflation, but at current pricing is also sure to be negative on a real basis.

I agree. I vaguely expect nominals to fare slightly better (but still negative real!). However, we hold ~40% of our F.I. in TIPS funds, expecting that we are probably paying a small insurance premium to hedge against rampant, unexpected inflation. Very similar to the viewpoint O.S. and big-papa espoused above.

 

[Markola]

I am not so optimistic. US inflation will almost certainly be either due to or a cause of the dollar declining in value. A significant decline, say, 20%, will result in a 25% increase in the landed dollar cost of all imports. That cost will be absorbed by the economy, probably mostly by consumers.

What will get hit? First, anything traded on world markets. Oil certainly, consequently plastics and other oil-derived chemicals. Food? Of course; meat (pork, chickens, ...) and animal feed (soybeans, maize aka corn, wheat, ...) Clothing. Consumer electronics. Metals (aluminum, steel, copper, ...) Substitution sounds good but IMO there won't be many places to hide.

Our houses? No place to hide there either. As values rise, the tax collectors will be along to extract the dollars they need to operate. Natural gas and electricity cost derive from international prices. Even water will rise as the water utilities try to recover their increased costs. Same-o for the wind and solar farmers.

Businesses will absorb some of the costs but guess who owns the business? We do, through our investments, public, and private pension assets, etc. People talk about businesses like they are bears in caves sitting on piles of money. Excusing for a moment executive salaries, there are no caves, no bears, and no piles of money. It is just us, the citizens, who eventually benefit from the business wins and suffer from the losses.

So ... IMO, really no place to hide "the majority" of our costs from high inflation.

Fair enough and let’s hope not. I’m up to 40% international equities now as one effort to address the weak dollar concern. I know you invest similarly in equities.

If TIPS are a viable solution, then one needs a high allocation to them to be effective remediation.

All this assumes that deflation won’t occur instead, which is a risk I can’t ignore, what with negative interest rates abounding around the globe.

 

[OldShooter]

... If TIPS are a viable solution, then one needs a high allocation to them to be effective remediation. ...

I agree completely. "Go big or go home." applies. Holding 5% of a portfolio in TIPS is a waste of basis points. IMO the TIPS tranche should be measured in withdrawal-rate-years. Three or four maybe. Our TIPS will/would cover us for four or five years.

The other thing I expect while simultaneously hoping to never see, is that rampant inflation will cause panic buying of TIPS. Treasury will cut off the supply, of course, to avoid pouring gasoline on the fire. So people in an emotional panic will, IMO, stop thinking YTM and instead just trying to buy inflation insurance at any price. So as we sell our TIPS for income, we could get pretty good prices.

Edit: Here's a reminder of Olden Times:

 

[pb4uski]

Hmmm, I must admit that I did not look up the current yields of nominal Treasuries when I posted that. But, looking this morning, a 3-year Treasury is paying 0.19%. I suppose it is possible, but I really expect inflation to be more than 0.2% p.a. over the next 3 years. Don't you? (But I fully admit that it could turn out differently, but I expect it to be higher.)



I agree. I vaguely expect nominals to fare slightly better (but still negative real!). However, we hold ~40% of our F.I. in TIPS funds, expecting that we are probably paying a small insurance premium to hedge against rampant, unexpected inflation. Very similar to the viewpoint O.S. and big-papa espoused above.

I agree that TIPs will be the place to be if we ever again have a spike of high inflation like in the 70s and early 80s and the Feds current actions have interest rates artificially low.

And I doubt that inflation for the next 3 years will be lt 0.2%... which I guess is why I've never owned a UST and certainly would not buy one now. At the same time, the Fed is struggling to meet its goal of 2% inflation, so who knows. TIPs are interesting, but I'm just not quite there yet.

 

[viking111]

Thank you for all the replies. Some the discussion went off topic a little.

The basic questions are as follows.

1. Lets say someone wants to spend 150K per year to spend for 10 years and then for example let the rest of their portfolio grow 60/40 and use it in 10 years to live. Is that a good idea and what would be the risk of doing that? If yes, which tips and how. Long term, short term, intermediate term etc. It would seem to me that they could do that and not worry about inflation.

2. Regardless of what one does. Are intermediate treasury in general better than total bond funds? Which is best to do or does it not really matter much?

 

[Out-to-Lunch]

I am not 100% sure of your proposed plan. I think you are suggesting:

-Put $1.5M into TIPS. Draw them down to 0 over 10 years.
-Meanwhile, put the rest of your stash into a portfolio with AA of 60/40.

Do I have that right?

If you have, say, 30x yearly expenses (which would be $4.5M based on what you have told us), then your overall AA (including the TIPS) would be 40/60 at the start of retirement, gliding to 60/40 after 10 years.

I would say that this plan sounds okay, but a bit conservative. I am actually planning to do something vaguely similar, but a bit less extreme.

yes, which tips and how. Long term, short term, intermediate term etc. It would seem to me that they could do that and not worry about inflation.

If I were to enact your plan, I would make a ladder of TIPS, to exactly match the duration of your spending plans. This is not difficult, thanks to the efforts of a boglehead participant: https://www.bogleheads.org/forum/viewtopic.php?t=93849


This plan assumes you can buy individual TIPS, as in an IRA. If you only have access to funds, you cna play around with different amounts of intermediate-term and short-term TIPS funds to match their duration to your remaining horizon.

 

[big-papa]

Thank you for all the replies. Some the discussion went off topic a little.

The basic questions are as follows.

1. Lets say someone wants to spend 150K per year to spend for 10 years and then for example let the rest of their portfolio grow 60/40 and use it in 10 years to live. Is that a good idea and what would be the risk of doing that? If yes, which tips and how. Long term, short term, intermediate term etc. It would seem to me that they could do that and not worry about inflation.

2. Regardless of what one does. Are intermediate treasury in general better than total bond funds? Which is best to do or does it not really matter much?

1. If you want $150K in inflation adjusted annual income, many wouldn't buy a TIPs fund since that would subject your cash flow to interest rate risk. Less risk for shorter duration, more for longer duration. Instead, the conventional method for this is to purchase a ladder of TIPs bonds. Many of the brokerage houses now have online tools to help you put this together. If you do this and don't sell before the bonds mature, then you have guaranteed the yield for the duration of every rung on the ladder and you'll know exactly what your cash flow will be in inflation adjusted terms. There are also ways to achieve something similar by holding TIPs funds of different effective durations and adjusting their ratios periodically to match the average duration of a true TIPs ladder at any point in time. Takes some time to understand and there is the downside of fund e/r's vs. a true ladder and there's some maintenance involved. Is building a ladder a good idea? The cost of doing this is definitely expensive given current rates. But only you can answer whether it's a burden or not. But I do know people who do this as a bridge between retirement starting and SS starting. Others, like myself, have built such a ladder for a different point in retirement, to supplement SS instead and will handle the bridge years differently.

2. This is a matter of personal taste. At least since the Volker era, with the long term trend of interest rates dropping, Treasury bond funds have tended to act a little better as ballast against market gyrations in the short term than total bond funds. On the other hand, many I know prefer total bond funds as part of their philosophy of "owning the whole market". And with total bond funds holding both corporate and treasuries, there's the possibility of slightly higher long term returns but of course that isn't guaranteed.

 

[viking111]

I am not 100% sure of your proposed plan. I think you are suggesting:

-Put $1.5M into TIPS. Draw them down to 0 over 10 years.
-Meanwhile, put the rest of your stash into a portfolio with AA of 60/40.

Do I have that right?

If you have, say, 30x yearly expenses (which would be $4.5M based on what you have told us), then your overall AA (including the TIPS) would be 40/60 at the start of retirement, gliding to 60/40 after 10 years.

I would say that this plan sounds okay, but a bit conservative. I am actually planning to do something vaguely similar, but a bit less extreme.



If I were to enact your plan, I would make a ladder of TIPS, to exactly match the duration of your spending plans. This is not difficult, thanks to the efforts of a boglehead participant: https://www.bogleheads.org/forum/viewtopic.php?t=93849


This plan assumes you can buy individual TIPS, as in an IRA. If you only have access to funds, you cna play around with different amounts of intermediate-term and short-term TIPS funds to match their duration to your remaining horizon.

Yes that was my plan. And yes it it conservative compared to a 40/60 or 50/50 portfolio.