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A Golden Age for Fixed Income Investing - Provided you use TIPS
Old 08-08-2022, 03:59 PM   #1
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A Golden Age for Fixed Income Investing - Provided you use TIPS

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.
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Old 08-08-2022, 06:16 PM   #2
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The brokerages push bond funds because that is what they make money from in trading fees and management expenses. If they could find a way to make money from individual TIPS, they would be advertising that they are the greatist thing since sliced bread. But they can't so they just act like they don't exist. The brokerages are in business to make money, which is why they come up with obtuse and long winded explanations of why you should stay the course in bond funds even now when many CDs from FDIC insured banks and Treasuries currently have higher yields, with no risk to principal and government backing, unlike the funds where another big drop in NAV is a possibility.

We have been individual TIPS fans since we researched what would be best for our retirement portfolio.
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Old 08-08-2022, 08:02 PM   #3
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I canít see any reason to compare the BH thread (which is nominal bond fund vs. Tips) to the thread here that is about potential opportunities in individual corporate bonds. The BH topic can stand on itís own.
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Old 08-08-2022, 08:41 PM   #4
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It doesn't have to be either/or (total bond vs TIPS).

Rick Ferri (do a google search) has suggested retirees have 20% of their fixed income in TIPS.
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Old 08-09-2022, 07:53 AM   #5
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It doesn't have to be either/or (total bond vs TIPS).

Rick Ferri (do a google search) has suggested retirees have 20% of their fixed income in TIPS.
Like many others I have a lot of respect for Rick Ferri but 20% doesn't make any sense. One of the bond experts in the Bogleheads threads suggests at least 50% of the total bond allocation in TIPS for those in the accumulation stage and 100% for retirees, while the OP in that thread and many others make (IMHO) a compelling case for TIPS of the appropriate duration being the best choice, period.
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Old 08-09-2022, 08:32 AM   #6
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Like many others I have a lot of respect for Rick Ferri but 20% doesn't make any sense. One of the bond experts in the Bogleheads threads suggests at least 50% of the total bond allocation in TIPS for those in the accumulation stage and 100% for retirees, while the OP in that thread and many others make (IMHO) a compelling case for TIPS of the appropriate duration being the best choice, period.
Yup. We belong to that church. IMO with TIPS it's go big or go home. Small percentages of net worth in TIPS seems silly; it isn't meaningful inflation protection and you're foregoing the higher yield you could be getting on straight govvies.

Our fixed income tranche has been near 100% TIPS since we bought them after we retired in 2006/7. And we bought the longest, lowest coupon TIPS available, the 2s of 26.
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Old 08-09-2022, 08:56 AM   #7
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Yup. We belong to that church. IMO with TIPS it's go big or go home. Small percentages of net worth in TIPS seems silly; it isn't meaningful inflation protection and you're foregoing the higher yield you could be getting on straight govvies.

Our fixed income tranche has been near 100% TIPS since we bought them after we retired in 2006/7. And we bought the longest, lowest coupon TIPS available, the 2s of 26.
Assuming the TIPS are in an IRA, how are RMD's managed? If interest rates are up at the time the RMD is due then presumably the value of the TIP bond is down then sell the bond at a loss?
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Old 08-09-2022, 09:08 AM   #8
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Assuming the TIPS are in an IRA, how are RMD's managed? If interest rates are up at the time the RMD is due then presumably the value of the TIP bond is down then sell the bond at a loss?

Admittedly I know little about bonds. But, I looked at the TIPs page and see 2% and 3% yields. How is this inflation protection?
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Old 08-09-2022, 10:06 AM   #9
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Assuming the TIPS are in an IRA, how are RMD's managed? If interest rates are up at the time the RMD is due then presumably the value of the TIP bond is down then sell the bond at a loss?
RMD's are taken in cash so it's up to the IRA holder to generate enough to meet the required amount. But you have 12 months to figure that out.
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Old 08-09-2022, 10:23 AM   #10
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Admittedly I know little about bonds. But, I looked at the TIPs page and see 2% and 3% yields. How is this inflation protection?
I don't know what page you are looking at but TIPS current yields are here. Those numbers are the yield plus you get CPI inflation added in, so they are paying more than I bonds right now.

United States Rates & Bonds - Bloomberg
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Old 08-09-2022, 10:26 AM   #11
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Assuming the TIPS are in an IRA, how are RMD's managed? If interest rates are up at the time the RMD is due then presumably the value of the TIP bond is down then sell the bond at a loss?
They really only make sense if you buy in a ladder and hold to maturity, and ideally in a retirement account to avoid phantom taxes on the inflation adjustments. If you have a ladder you will have some maturing regularly for RMDs. We don't have 100% TIPS in our entire portfolio so would always have some other asset class to sell off.

Sure funds are easier, but they come at a cost. In a high inflation, rising rate environment like this year, bond funds are yielding maybe 2 - 3% and lost 10% or so on the NAV, while older TIPS were making 2% and increasing 8 - 9% on the inflation factor. If you have a 6 figure or higher bond portfolio that is a pretty huge earnings difference, -7% vs. +10%. On a $1M bond portfolio that is the difference between losing -$70K vs earning $100K.
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Old 08-09-2022, 10:53 AM   #12
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They really only make sense if you buy in a ladder and hold to maturity, and ideally in a retirement account to avoid phantom taxes on the inflation adjustments. If you have a ladder you will have some maturing regularly for RMDs. We don't have 100% TIPS in our entire portfolio so would always have some other asset class to sell off.
I see, then one has to manage the ladder and pick what to buy and sell each year for the RMD withdrawals. I think I could do it now (I'm 72) but wonder about cognitive issues down the line. Also my wife has absolutely no interest or knowledge re managing investments in an active fashion. I like the idea of TIPS but I'm concerned about the mechanics of managing individual TIPS issues.
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Old 08-09-2022, 11:00 AM   #13
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I don't know what page you are looking at but TIPS current yields are here. Those numbers are the yield plus you get CPI inflation added in, so they are paying more than I bonds right now.

United States Rates & Bonds - Bloomberg

OK, that helps.

So the 1yr TIPS paying 3.26% now, will have the 9.1% CPI added to it at maturity? 3.26 + 9.1 = 12.36% ?

And the 2 yr, will have 9.1% added for this year and also whatever the CPI is next year?
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Old 08-09-2022, 11:08 AM   #14
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Assuming the TIPS are in an IRA, how are RMD's managed? If interest rates are up at the time the RMD is due then presumably the value of the TIP bond is down then sell the bond at a loss?
Well, start with the fact that they are in a tIRA, so notions of gain and loss are irrelevant. Until last year, equities were strong enough that our RMDs came from that tranche. Last year we committed to build a new house, so I sold a bunch of equities around mid-year and put the money into SWVXX. RMDs came from there but the truth is it's like a hand grenade went off in the fixed income tranche. We'll be far over the RMD amounts for 2021-2023 so they just go into an overall tax planning strategy bucket.

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RMD's are taken in cash so it's up to the IRA holder to generate enough to meet the required amount. But you have 12 months to figure that out.
Exactly.

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I see, then one has to manage the ladder and pick what to buy and sell each year for the RMD withdrawals. I think I could do it now (I'm 72) but wonder about cognitive issues down the line. Also my wife has absolutely no interest or knowledge re managing investments in an active fashion. I like the idea of TIPS but I'm concerned about the mechanics of managing individual TIPS issues.
I don't know why there's anything special about individual TIPS here vs individual govvies. We're not bond fund people (that's a debate for another thread) but possibly you wold view TIPS funds as an attractive simplification.
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Old 08-09-2022, 11:20 AM   #15
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I see, then one has to manage the ladder and pick what to buy and sell each year for the RMD withdrawals. I think I could do it now (I'm 72) but wonder about cognitive issues down the line. Also my wife has absolutely no interest or knowledge re managing investments in an active fashion. I like the idea of TIPS but I'm concerned about the mechanics of managing individual TIPS issues.

Well, I don't know what to tell you. Buying TIPS at auction to develop a ladder, once you understand how they work, takes maybe a few hours a year. We spent more time than that this year on picking a contractor to install a new vapor barrier in the crawl space. I have absolutely no major interest in crawl space barriers, but I do like a healthy house as well as a well funded retirement, so I spent time researching both TIPS and crawl space barriers. If you get cognitive decline you still have to worry about things like hiring contractors (if you own a home), filling out your income tax forms and understanding your Medicare statements, so TIPS might be the least of your worries.
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Old 08-09-2022, 11:24 AM   #16
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OK, that helps.

So the 1yr TIPS paying 3.26% now, will have the 9.1% CPI added to it at maturity? 3.26 + 9.1 = 12.36% ?

And the 2 yr, will have 9.1% added for this year and also whatever the CPI is next year?

What page are you looking at with a 3.26% yield?
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Old 08-09-2022, 11:43 AM   #17
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Well, start with the fact that they are in a tIRA, so notions of gain and loss are irrelevant.
I'll be the first to admit I'm an ignoramus when it comes to investing but if I bought something in my Tira at $100 and have to sell it at $90 to cover my RMD I would not be happy. Particularly a conservative investment that I would hope would protect both my principal and hopefully keep up with inflation. But I think I understand your point. All investing is risky- just in different ways.
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Old 08-09-2022, 11:56 AM   #18
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I'll be the first to admit I'm an ignoramus when it comes to investing but if I bought something in my Tira at $100 and have to sell it at $90 to cover my RMD I would not be happy. Particularly a conservative investment that I would hope would protect both my principal and hopefully keep up with inflation. But I think I understand your point. All investing is risky- just in different ways.
Well, two factors. First, for tax purposes gains and losses are irrelevant in a tIRA. The psychological aspects, though, are hard to ignore. The behavioral economists tell us that we are loss-averse animals. This affects our actions but it also causes us to play little games with ourselves. One is "I'll sell it as soon as it gets back to my buy price." another "I won't sell at a loss (despite that the loss is real, just not realized.)."

Both Daniel Kahneman and Richard Thaler deal with risk aversion in their books. "Thinking Fast and Slow" and "Misbehaving.' IMO it's an important thing for investors to understand and factor into their own decisions.

Another way to think about it is to understand the sunk cost fallacy. (https://en.wikipedia.org/wiki/Sunk_cost) One of Buffett's gem quotations is "Ignore sunk cost, assume no one else does." To your point, what you paid for an asset is completely irrelevant (except for tax reasons) to a sell decision.
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Old 08-09-2022, 12:07 PM   #19
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I'll be the first to admit I'm an ignoramus when it comes to investing but if I bought something in my Tira at $100 and have to sell it at $90 to cover my RMD I would not be happy. Particularly a conservative investment that I would hope would protect both my principal and hopefully keep up with inflation. But I think I understand your point. All investing is risky- just in different ways.

No one here has suggested going to a 100% TIPS portfolio, not in a ladder and having to cash some in prior to maturity, so I don't understand why you are even bringing it up. TIPS work best when you buy individual TIPS and hold to maturity. With a ladder you will have some rungs mature periodically for your RMDs. If you have 5 year rungs then put the maturing money into under 5 year Treasuries or 1 - 4 year maturing TIPS bought on the secondary market, if those rates look good. Problem solved. Or sell from your stock allocation. You are trying to solve a problem that you would be hard pressed to even create in the first place.
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Old 08-09-2022, 12:59 PM   #20
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No one here has suggested going to a 100% TIPS portfolio, not in a ladder and having to cash some in prior to maturity, so I don't understand why you are even bringing it up. TIPS work best when you buy individual TIPS and hold to maturity. With a ladder you will have some rungs mature periodically for your RMDs. If you have 5 year rungs then put the maturing money into under 5 year Treasuries or 1 - 4 year maturing TIPS bought on the secondary market, if those rates look good. Problem solved. Or sell from your stock allocation. You are trying to solve a problem that you would be hard pressed to even create in the first place.
OK, I again apologize for my ignorance but I read, I think elsewhere on this thread that Oldshooter has 100% TIPS for fixed income and I think I also read that its the best Idea to have bonds in tIRA and stocks in taxable so if I have all my TIPS in tIRA then I don't see how I avoid selling some TIPS to pay my RMD. So if I understand what you are saying is that the advice to have all bonds in tIRA is incorrect and I should also have some stocks in tIRA.
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