Fixed Income Strategy for Beating Inflation

[haha]

Quote:

Originally Posted by Running_Man The current interest rate and relation to inflation has no impact on success or failure other than the starting draw as a percentage of portfolio.

Yes, that is clear enough. It is also clear that a person in today's world would have to be very well to do or able to live like a 3rd-worlder to even get going with this plan.

Ha

[cute fuzzy bunny]

BTW, I'm not suggesting this approach has anything to do with bravery or cowardice.

I think its beneficial to point out that someone looking at this is simply exchanging immediate volatility risk with long term buying power risk. There is still no free lunch.

It doesnt take any complex calculations to evaluate this approach. Long term bonds vs long term inflation suggests a sub 2% real return...more to the point its under 1% most of the time.

You could use tips and get 1.7-1.8 for the 20 year variety.

So its that simple: can you live on something between 1 and 2% of your portfolio? If so then this would work without draining principal. Presuming your personal rate of inflation is equal to or less than the CPI and if you're using conventional 30 year treasuries, that there are no long periods of high inflation. Eight to ten years of 8-10% inflation would pretty much finish you off.

[W2R]

Quote:

Originally Posted by cute fuzzy bunny Eight to ten years of 8-10% inflation would pretty much finish you off.

Now there's a cheery thought.

I think 8-10% inflation for 8-10 years would finish many of us off, no matter how carefully we arranged our portfolios. That would represent an increase in prices of 185% to 259% over 8-10 years. Yikes!

[cute fuzzy bunny]

If I remember right, in the ten year period from 1973 until 1982 inflation averaged somewhere between 8 and 9%. Closer to 9 than 8.

Bond and CD rates were better then, though. If you had a lot of guts and bought some bonds or long term cd's near the end of that time, you'd have done well.

[CitricAcid]

Quote:

Originally Posted by Want2retire Now there's a cheery thought. I think 8-10% inflation for 8-10 years would finish many of us off, no matter how carefully we arranged our portfolios. That would represent an increase in prices of 185% to 259% over 8-10 years. Yikes!

I think you mean INCREASE of prices of 85-159%, or things are 1.85-2.59x more expensive than they were at the start, not too big a deal but still makes a difference, especially with the small time frame.

I think what RunningMan is really trying to show is that even with bonds being considered a poor investment vehicle during inflation, historically they do have some inflation-defeating abilities. Right now the yields are incredibly low, but if you DO see years of 8-10% inflation, I would soon expect years of 10-12% federal funds rate, which would be graet yields and then as inflation comes down they will cut rates boosting up the prices even more. In other words, I think that the performances heading forward for bonds will be in between what the landscape is now and what it had been in the early 80s.

[W2R]

Quote:

Originally Posted by cute fuzzy bunny If I remember right, in the ten year period from 1973 until 1982 inflation averaged somewhere between 8 and 9%. Closer to 9 than 8. Bond and CD rates were better then, though. If you had a lot of guts and bought some bonds or long term cd's near the end of that time, you'd have done well.

Definitely not a good decade for non-COLA'd fixed income!!

I remember those times. Pretty awful.

[W2R]

Quote:

Originally Posted by CitricAcid I think you mean INCREASE of prices of 85-159%, or things are 1.85-2.59x more expensive than they were at the start, not too big a deal but still makes a difference, especially with the small time frame.

Yes, you're right. Prices multiplied by a factor of 1.85-2.59 . Sorry!

[cute fuzzy bunny]

Quote:

Originally Posted by CitricAcid I think what RunningMan is really trying to show is that even with bonds being considered a poor investment vehicle during inflation, historically they do have some inflation-defeating abilities.

I dont think anyone has ever debated that bonds produce a return in excess of inflation. I think whats been suggested is that someone trying to live off a fixed income only portfolio and taking a reasonable 3-4% withdrawal will find their purchasing power fade over time. If you can manage getting by on a sub 2% withdrawal, then an all fixed income strategy works.

Quote:

Right now the yields are incredibly low, but if you DO see years of 8-10% inflation, I would soon expect years of 10-12% federal funds rate, which would be graet yields and then as inflation comes down they will cut rates boosting up the prices even more. In other words, I think that the performances heading forward for bonds will be in between what the landscape is now and what it had been in the early 80s.

No doubt. But how does that work in an investment strategy? Buying today you'd have a bunch of low yielding bonds which you'd have to sell in order to buy the newer higher yield bonds. Except you'd sell for a lower bond price proportional to the differential in rates for roughly the same YTM.

Do you sit in cash waiting for lightning to strike and buy then?

At what point in the process of waiting while inflation and rates fly up do you bite the bullet and buy in?

You could ladder the bonds, but then you'd be taking a lower yield for a large portion of your portfolio and that would probably dip you below the inflation threshold. Unless I'm mistaken the proposal here is to buy 30 year bonds and then sit tight.

Its not really that much different from any other sort of market timing.

All that having been said, my dad got burned in the stock market in the early 70's and ended up never owning equities again. He plowed his money into 30 year treasuries that paid an average of 8% and has made a nice retirement out of it. Paid off his house and lives off of about 20k a year. He did have a pretty good stash put away.

Right now he's 75, in very good health, and has about 250k worth of those bonds left. Most have either just matured or will soon. Now what?

[CitricAcid]

To CFB,

It is very tricky to say depending on the situation, and what I am saying does sound similar to market timing. However, with the fed funds rate so low right now and inflation ratcheting up, I would find it hard to buy bonds right now. When will the outlook look better? 3 years? 5 years? 100 years? I am not certain, however they will perform better than they are now by a significant amount.

All in all, I feel it depends how close you are to shifting your AA to more fixed income that the issue matters the most of curent bond yields. I am not even close to this phase yet, so I have no problems waiting.

[Running_Man]

Quote:

Originally Posted by cute fuzzy bunny BTW, I'm not suggesting this approach has anything to do with bravery or cowardice. I think its beneficial to point out that someone looking at this is simply exchanging immediate volatility risk with long term buying power risk. There is still no free lunch. It doesnt take any complex calculations to evaluate this approach. Long term bonds vs long term inflation suggests a sub 2% real return...more to the point its under 1% most of the time. You could use tips and get 1.7-1.8 for the 20 year variety. So its that simple: can you live on something between 1 and 2% of your portfolio? If so then this would work without draining principal. Presuming your personal rate of inflation is equal to or less than the CPI and if you're using conventional 30 year treasuries, that there are no long periods of high inflation. Eight to ten years of 8-10% inflation would pretty much finish you off.

Eight to ten years of 10 percent inflation would increase the 30 yield treasury back to the 12 percent range and that would be the best possible time to start this strategy. However even the original strategy would maintain their inflation indexed spending unless the 30 year bond was yielding 5 percent while inflation is averaging 10 percent, not very likely.

Since the spending pool is exactly equal to the savings pool and the higher inflation will be met with higher interest rates. 1973 - 1980 averaged 9 percent inflation per year, yet by 1982 the total interest earned under this method was 5.75 percent above the inflation rate because the increased inflation expectation increased 30 year yields to well above the inflation rate. This continued with the 30 year bond through 1983-1986 with rates yielding 5-6 percent above the inflation rate. So in actuallity I believe a high inflation period without going into hyperinflation would actually greatly benefit this strategy.

I totally agree the withdrawl rate is too low right now to be practical, but with the Fed so concerened with recovering housing prices, in the near future long term rates could rise rapidly.

[cute fuzzy bunny]

Quote:

Originally Posted by Running_Man Eight to ten years of 10 percent inflation would increase the 30 yield treasury back to the 12 percent range and that would be the best possible time to start this strategy.

I agree. But how does the investing mindset enter into this equation? Looking back on the last few weeks of threads here, plenty of people are running screaming for the exit door or contemplating doing so when equities have become inexpensive and better buys than they were a year ago.

Looking at runaway inflation and rising rates, would someone have the cojones to buy a bunch of 30 year bonds?

Lets look at the pairings of inflation and 30 year yields, against the backdrop of having just gotten out of vietnam, the president having been impeached and resigned, the cold war, the USSR invading afghanistan, iran seizing and holding our embassy personnel as hostages, etc...

Year 30 year inflation
1973 7.010 6.16
1974 7.620 11.03
1975 8.050 9.2
1976 7.200 5.75
1977 7.940 6.5
1978 8.880 7.62
1979 10.120 11.22
1980 12.400 13.58
1981 13.450 10.35
1982 10.540 6.12
1983 11.880 3.22
1984 11.520 4.3

Probably would have been tempting to buy in 1976 when you had a good spread against inflation and a couple of bad years financially seemed to be behind us. I'm guessing most 100% bond investors who bought then would have been pretty nervous by 1981.

Would have been pretty good to buy in 1980 or 81 although it seemed pretty likely we'd be at war pretty soon, it was just a question of with whom.

Even with the data in front of you and full hindsight, its kinda tough to figure out where you could/would have gotten in.