Better inflation hedge: TIPs or Wellesley?

[brewer12345]

Lots of fun to watch though!

Only the first 500 times. :

 

[unclemick]

Soooooo - how do we weave into this thread the inflation fighting power of mortgaged/not mortgaged real estate and then for a grand flourish - cap it off with the sweetie who crushes beer cans.

heh heh heh - ?does the price of recycled AL cans outpace inflation?

Still cheering for - Psst Wellesley after all these years. Go team go!

 

[wabmester]

Only the first 500 times. :

Hey, we do what we can for edutainment around here.

I tried to spin it a little differently this time by shifting the debate to past performance vs the predictive power of current yields to spice things up a bit....

 

[sgeeeee]

This is why I don't ask for investment advice from this board.

 

[wabmester]

This is why I don't ask for investment advice from this board.

That brings up an interesting point: what is good investing advice?

Some people like to hear the word of god their favorite pundits.

Some people like to hear what fits best into their existing belief system.

Some people like to hear what the historical data says.

Some people like to hear predictions of the future.

Personally, I like to see what the historical data says about the "physics" of investments, and then I try to apply those laws of physics to the current environment and possible future scenarios. If nothing else, this keeps me constantly and easily entertained.

 

[Rich_by_the_Bay]

This is why I don't ask for investment advice from this board.

Clinton did it.

 

[Alan]

Personally, I like to see what the historical data says about the "physics" of investments, and then I try to apply those laws of physics to the current environment and possible future scenarios. If nothing else, this keeps me constantly and easily entertained.

I think the only law of physics that applies to investmenting in financial markets is Heisenberg's uncertainty principal.

http://en.wikipedia.org/wiki/Uncertainty_principle

 

[unclemick]

That brings up an interesting point: what is good investing advice?

Now that I have my Curmudgeon certificate and are in the distribution phase of ER - I've been thinking of phasing out DeGaul and the Norwegian widow and moving on into advanced or graduate level:

Chickenheartedness.

I do hesitate at the thought of doing a book given my writing abilities - but perhaps with a good ghost writer.

On the other hand - a man's got to know his limitations - mabbe just frame the certificate and buy that kayak.

heh heh heh heh - 85% Target Retirement, 15% Norwegian widow stocks - unless I start 'thinking and investing'. 8)

 

[wabmester]

I think the only law of physics that applies to investmenting in financial markets is Heisenberg's uncertainty principal.

That's true to a large extent for capital gains. Human behavior is unpredictable (not just at the quantum level, but at the complexity level).

BUT... "physics" tells you that Wellesley's returns come from a combination of capital gains and yield. SO... if the current yield is at a record low, what does that tell you about future returns?

Three related things: 1) the yield-based shock absorbers are shot so expect more downside volatility, 2) returns will probably be lower on average, 3) returns will be much more dependent on the somewhat whimsical capital gains component.

What's interesting about Wellesley in the context of this discussion (inflation hedge) is that inflation has an almost physics-like impact on bond yields, and bond *values* react in a physics-like manner based on their duration. So, the 65% component of Wellesley that is in nominal bonds makes the fund's behavior pretty predictable in the face of whatever inflation scenario you want to throw at it.

 

[cute fuzzy bunny]

Gosh Wab, if the current yield actually WAS at a record low, and you could guess the future, and the future was completely different from the past 35 years...you might have a point.

However, the funds yield is NOT at an all time low, you cant guess the future, and i'd guess the next 35 years to be a lot like the last 35, only all mixed up a bit differently

I also did NOT go into cash to wait for the S&P500 to hit 1000. I went partially into cash to purchase a home and refit it, and when I sell the old one i'll reinvest. Should the S&P hit 1000 between now and then, I suppose I'd be pleased. If it hits 2000, the other million or so i've got in equities will make me pleased.

Maybe one more time i'll suggest you revisit the effects of "persistence"...

 

[wabmester]

Gosh Wab, if the current yield actually WAS at a record low, and you could guess the future, and the future was completely different from the past 35 years...you might have a point.

However, the funds yield is NOT at an all time low, you cant guess the future, and i'd guess the next 35 years to be a lot like the last 35, only all mixed up a bit differently

[OK, I'll walk right into this one. I can't wait for the punchline.]

Vanguard sez the current yield on Wellesley is 4.27%. It looks like it might have been a few basis points lower in 2005, but this looks to me to be pretty close to a historic low for both stock and bond yields. Please tell us, fuzzy one, what was the historic low yield for the fund, and how did it perform during that period?

And knowing a bit of physics doesn't really help you predict the future, it just helps you know how something behaves given certain conditions. Since I don't know what the future might bring, I recommend a mix of nominals and inflation-indexed bonds for one's bond allocation, and I like Swedroe's allocation recommendations which are based on the historical performance of nominal bonds and inflation.

 

[cute fuzzy bunny]

Ah, so almost half a point is "a few basis points". I think i'm getting a handle on your advice. Make sweeping and incorrect generalizations, ignore important details while making unimportant ones seem crucial, then make inaccurate claims about contrasting details.

Just for the record, we dont get french benefits either.

Persistence also has very little to do with physics in this case. Persistence in both weather forecasting and in investment practices simply says that what is to come is most likely a lot like what has already happened and is happening now.

Persistence is also a better predictor of the weather and investing than people are. By quite a bit.

The funny thing with persistence is that if you increase the time window from a few days/weeks to a few months or years, it stops being a good predictor. Then once you get past that to windows a few years or more, it starts becoming a better predictor again.

All along the line, in each period, the predictive abilities of people still sucks.

Which is why index funds always outperform managed funds over longer periods of time.

The common sense also turns out to be quite common but not always sensible. Four years ago when I was a heavy wellesley investor (not a single share these days) everyone here (including you) said that I should get out. Rising interest rates were going to torpedo the fund, perhaps cutting 15-20% from the asset value.

Never happened.

So while theres nothing magical about the mixture and as has been demonstrated, no particular managed fund benefit to the mix, its cheap, simple, requires very little knowledge or effort on the investors part, and it works.

In my prior analysis from a few years ago, I took the funds total returns, separated the dividends, applied that years inflation figure, and wrapped the data so the end went back to the beginning...sort of a 'mini firecalc'. In that analysis, one could have invested at any point in the funds lifespan, taken 4%, reinvested excess dividends, and never run out of money despite the effects of inflation. In fact, you'd pretty much have a nearly intact, inflation adjusted principal while taking your 4%.

Which seems a bit better than the 2% offered up by most CPI indexed securities these days.

So unless 2007-2047 is going to be markedly different than 1970 to 2007, I cant see how one can make a case for it being a "poor inflation hedge". And my crystal ball isnt working right now.

 

[wabmester]

Ladies and Gentlemen of the jury:

My esteemed fuzzy colleage would have you believe that stocks are like the weather and have you place your faith in "persistence." He did his own "firecalc-like" analysis and determined that the fund will provide you with the current yield (4%) + inflation-protected principal. Just like TIPS with a 4% real yield!

My analysis is much simpler and requires no such faith. The fund is comprised of 65% nominal bonds. These bonds have an average yield of around 5%, an embedded inflation estimate of around 2.5%, and a duration of 5.7 years.

I make no predictions about future interest rates or inflation, but I can tell you that those bonds will behave in an utterly predictable fashion whatever changes may come. If rates go up by 1% due to inflation or other factors, those bonds will loose 5.7% of their value. At a 2% increase, they will loose 11.4% of their value. Of course, the same applies in the other direction as well, but we know there is a hard limit to how far rates may fall, while there is no limit on high how they may go.

And in comparison to TIPS, those nominal bonds will underperform in the long-term if inflation exceeds an average 3% over their lifetime. That is not a prediction. That is just how bonds work.

Historically, stocks have returned a rate of GDP - 2% + dividend yield. Dividends are currently near a historic low, so we might very well see lower returns from stocks than we have in the past, but the 35% component of the fund in stocks should keep up with inflation as well or better than TIPS as long as GDP growth stays reasonably robust in the coming years. Last quarter's GDP growth of 1.3% (+ inflation) and the current dividend yield aren't great signs for future stock returns, but that's something that irrational exuberance might always "fix." Hey, it worked in the past!

Bottom line: stocks are volatile, but their long-term returns should be fairly predictable. You should choose your allocation to stocks based on your appetite for risk and how well you are being compensated for that risk.

Where my colleage and I both agree is that Wellesley has no magic components. Ultimately, this is an asset allocation decision. I see no compelling reason to go with Wellesley's all-nominal bond approach to the bond portion of that allocation.

 

[haha]

Enough with your pointy-headed intellectuality!

Ha

 

[REWahoo]

Ladies and Gentlemen of the jury:

I regret to inform you that a jury of your peers could not be located and the both of you have been arguing your case to an empty courtroom for some time. We tried to get Judge Judy to hear the case but she recused herself, citing extreme apathy as the basis for her action.

Carry on...

 

[twaddle]

Carry on...

I regret to inform you that I have taken wab. This really was his final argument. His number is up. His sin, you ask? Spelling "lose" as "loose." Twice! In the same paragraph!

Let this be a lesson....

 

[lswswein]

Both you geeks need to start firing up excel spreadsheets; We need hard facts on what ever you are talking about. before making anymore comments. Though posting after the God guy I am afaird he might send a bolt of lighting my way.

-h

 

[sgeeeee]

Clinton did it.

We may not get everything right on this board, but I think we have successfully established at least this one truth.

 

[cute fuzzy bunny]

I think Clinton holds quite a bit of wellesley!

Sorry Wab, but you're presuming that Wellesley would hold the same bonds forever, never buying new ones or exchanging older ones.

Unfortunately, thats not what happens.

We've already exhaustively determined that there is no premium in TIPS vs similar non indexed treasuries...if there were, nobody would own the "loser". Theres just a period where one may exceed the other until market pressures equalize the differential.

In the meanwhile, the chunk of equities gives you an actual return while the bond chunk settles down the volatility to a satisfactory level.

And there ya go with that "rates go up 1%, bonds lose 5.x% of their value" routine. Huh. Rates just went up 4%. Wellesley's nav went up. How the heck did that happen?

The bottom line is unless you have a LOT of money or dont spend much, a 2% tips allocation just keeps you from losing too badly and is only appealing in times of very high inflation.

And you have to put more than a dollop of money into them to have the 'hedge' be reasonably effective.

So over the long term, you can take substandard returns and then just not lose too much if and when we hit a long term high inflationary period, or you can take your 8-11% returns with low volatility and low loss risk at a low management cost and enjoy your life...and a lot more money.

Sounds like a sucky approach.

Or you can keep telling me that you know how things are going to unfold, when nobody does, or that things are going to behave in a certain way, when they dont always.

Or you can tell me where else you're gonna put your money. TIPS returns in less than high inflationary periods suck. Equities are fully priced. Junk stinks. Real estate is overpriced. Hmm, cash is paying pretty well, but you already tried to zap me on having a large cash position, so I guess you cant go that way.

Just so i'm clear on this, is it still an inflation hedge if you dont make money most of the time or lose 20-30% of the principal value?

 

[twaddle]

[Wab is in limbo right now while I thumb-wrestle various parties for control over his soul. In the meantime, he is forcing me to channel this message....]

Sorry Wab, but you're presuming that Wellesley would hold the same bonds forever, never buying new ones or exchanging older ones.

Unfortunately, thats not what happens.

We've already exhaustively determined that there is no premium in TIPS vs similar non indexed treasuries...if there were, nobody would own the "loser". Theres just a period where one may exceed the other until market pressures equalize the differential.

Fuzzy, you ignorant slut.

Yes, the price and yield of nominals would obviously equalize to match TIPS. How would they do that? If inflation went up, the yield of nominals would go up by way of their price going down. The only way to "exchange" the bonds held by the fund would be to sell them at a capital loss.

And there ya go with that "rates go up 1%, bonds lose 5.x% of their value" routine. Huh. Rates just went up 4%. Wellesley's nav went up. How the heck did that happen?

You're confusing rates with rates.

The physics of bonds is not a function of pick-your-favorite-rate, like the fed funds rate which went up in the last few years. It is a function of the *market* rates for the specific bonds in question. For example, when the fed funds rate goes up, that affects *short-term* rates, and if you were paying attention recently, short-term bond values fell in proportion to their duration when their market rates went up.

Puuuuhlease get your facts straight before wab makes me get off my cloud again.....

 

[cute fuzzy bunny]

God, you second rate deity.

But then again, apparently even God has to use the worst case scenario to attempt to prove his weak, lame point as his actual argument appears to have already been defeated by almost 40 years of solid proof otherwise.

 

[clifp]

Wow God has joined the thread, what is next *****?

 

[Eagle43]

Wow God has joined the thread, what is next *****?

Well, I was talking to SATAN the other day, and she said....

 

[riskadverse]

... Spelling "lose" as "loose."

Thank God . . . to too is forgivable, but loose lose is not.

 

[REWahoo]

Thank God . . . to too is forgivable, but loose lose is not.

So, what's the morale moral of this story?