Which Asset Classes Protect Against Inflation by Larry Swedroe

[razztazz]

I can help you with that. From 1966-1982 inflation was about 6.8%. The return of the S&P during that time? About 6.8%.

Thanks. Not what I'd call a hedge against inflation. More like the thing that barely succeeded in spite of not because of inflation

 

[eytonxav]

The genius of portfolios can be checked here:
https://portfolioslab.com/lazy-portfolios

Since we're in the thick of inflation, the 1-year returns of various portfolios are informative, at a minimum.

Finding a better portfolio design requires a lot of thought, IMO.

That's an interesting summary of different approaches. I wonder what the consensus selections would be from our market experts if one had to start a new portfolio in the current environment?

 

[jim584672]

Stocks in the 70s had dividend yields of 3% to 5% which was a big factor in total return. Now we have 1.3%. I can't see stocks zooming up in price to the degree needed to keep up with inflation this time. They are not cheap by any measure.

 

[target2019]

That's an interesting summary of different approaches. I wonder what the consensus selections would be from our market experts if one had to start a new portfolio in the current environment?

My simple rule-of-thumb is as follows.
1) 90% equity and 10% fixed up to 50 years of age.
2) Make 4% adjustment each year, and that can be done by changing 401(k) and IRA contributions to stable or guaranteed. That means 10 years of gradually reducing equity exposure.
3) At 60 years of age, you are 50% equity.
4) Enjoy your retirement!

One challenge is finding appropriate investments in several different accounts that can fit the goal and timeframe.

 

[OldShooter]

My simple rule-of-thumb is as follows.
1) 90% equity and 10% fixed up to 50 years of age.
2) Make 4% adjustment each year, and that can be done by changing 401(k) and IRA contributions to stable or guaranteed. That means 10 years of gradually reducing equity exposure.
3) At 60 years of age, you are 50% equity.
4) Enjoy your retirement! ...

Good on you if this algorithm is appropriate to your situation. I am reminded, though, of HL Mencken's admonition: "For every complex problem, there is a solution that is simple, neat and wrong.”

In our situation, for example, your recipe would be a bad choice. We're 74 and the amount of money we're likely to need to support our lifestyle in the future is far less than 50% of our portfolio. Running a substantially higher equity % is very appropriate as it will probably maximize the money our heirs and charitable donees will receive.

In another situation where the retiree has very limited funds to supplement SS income, 50% equities may well be foolish.

Finally, the "sleep at night" test may make 90% equities untenable for some younger people. I tend to agree with you that 90% is a good number, but if it causes people to panic sell into a market decline then it is not a very good number for them at all.

One size hardly ever fits all.

 

[razztazz]

That's an interesting summary of different approaches. I wonder what the consensus selections would be from our market experts if one had to start a new portfolio in the current environment?

I think that site Portfolio Charts actually runs a list of all their "donut" portfolios pros & cons, and one of their comparison points is "Sensitivity to start date." If I'm remembering correctly and they haven't introduced any new ports' the Harry Brown 25/25/25/25% one is the least sensitive to market conditions when you start. The ones with the highest equity loads are the most sensitive. Pick a good year/epoch and you're rich. Pick a worser time and you might survive but it could be a little too interesting in your old age.

 

[razztazz]

Stocks in the 70s had dividend yields of 3% to 5% which was a big factor in total return. Now we have 1.3%. I can't see stocks zooming up in price to the degree needed to keep up with inflation this time. They are not cheap by any measure.

I was going to mention this but, hey, it's a weekend.

 

[Fermion]

If it was not so scary, it really makes you want to go with stocks that are paying a 4% or 5% dividend (or higher). This would mostly be biotech right now though, kind of risky.

 

[DaveInMi]

I think a well balanced portfolio should have some precious metals. I believe we will see a surge in silver prices in the near future. Gold hit a record (briefly) last month. If the USD is replaced as the global currency, then PMs here will skyrocket, as will inflation.

 

[kevink]

Newly purchased TIPS are negative below the 20 years. But TIPS purchased previously, like at 2.5% after the last recession as mentioned in the article, are currently returning 2.5% + 8.5% inflation factor = 11%. I don't know what you mean by not enough history or they performed poorly during market crashes.

TIPS have only been in existence since 1997; that's what I mean by "not enough history." And as for performing poorly during market crashes, they cratered during the 2008 market crisis at the very same time that longer-term nominal treasuries soared. From Investopedia:

"On the other hand, TIPS have very real issues during periods of financial stress when traditional Treasury bonds shine. The problem is due to the way the government designed the deflation floor for TIPS. The Treasury guarantees that the principal for TIPS will not fall below the original value.

However, later upward adjustments for inflation can be taken back if deflation occurs. Therefore, newly issued TIPS offer much better protection from deflation than older TIPS with the same time to maturity. When deflation becomes an issue, as it did in 2008 and again in March 2020, TIPS ETFs, such as the iShares TIPS Bond ETF (TIP), declined significantly."

Obviously those who bought individual TIPS back when they offered positive real yields are doing very well. But there are good reasons TIPS aren't part of defensive allocations like the Permanent Portfolio or Golden Butterfly. Right now iBonds are the only "TIPS" I'd be comfortable buying - perhaps supplemented by a bit of VTIP as a "less worse" short-term bond fund.

 

[daylatedollarshort]

TIPS have only been in existence since 1997; that's what I mean by "not enough history." And as for performing poorly during market crashes, they cratered during the 2008 market crisis at the very same time that longer-term nominal treasuries soared. From Investopedia:

"On the other hand, TIPS have very real issues during periods of financial stress when traditional Treasury bonds shine. The problem is due to the way the government designed the deflation floor for TIPS. The Treasury guarantees that the principal for TIPS will not fall below the original value.

However, later upward adjustments for inflation can be taken back if deflation occurs. Therefore, newly issued TIPS offer much better protection from deflation than older TIPS with the same time to maturity. When deflation becomes an issue, as it did in 2008 and again in March 2020, TIPS ETFs, such as the iShares TIPS Bond ETF (TIP), declined significantly."

Obviously those who bought individual TIPS back when they offered positive real yields are doing very well. But there are good reasons TIPS aren't part of defensive allocations like the Permanent Portfolio or Golden Butterfly. Right now iBonds are the only "TIPS" I'd be comfortable buying - perhaps supplemented by a bit of VTIP as a "less worse" short-term bond fund.

TIPS ladders and ETFs are not the same thing. With individual TIPS bonds, at maturity, if the adjusted principal is less than the security's original principal, you are paid the original principal. TIPS bond funds have some of the same issues that nominal bond funds are having right now. They don't mature and you aren't guaranteed of ever getting your principal back.

Stocks lose money during market crashes, too, and there have been many more market crashes than deflationary periods so I guess I still don't really understand your point. Do you think TIPS are more risky overall than stocks? Most people have diversified portfolios as different asset classes do well in different economic times. I don't think anyone here is recommending 100% TIPS, but they do help save the day during high inflationary periods like we are in right now, which was the point in the Swedroe article.

If you are very concerned about prolonged deflation, then TIPS may not be a good choice for your portfolio. However, we have been more concerned about the possibility of inflation eroding the value of our investments in retirement ourselves - "Deflation rarely occurred in the second half of the 20th century. In fact, the dramatic and consistent price increases from 1950 to 2000 has been unparalleled since the founding of the country." https://www.investopedia.com/ask/an...re-any-periods-major-deflation-us-history.asp

 

[kevink]

TIPS ladders and ETFs are not the same thing. With individual TIPS bonds, at maturity, if the adjusted principal is less than the security's original principal, you are paid the original principal. TIPS bond funds have some of the same issues that nominal bond funds are having right now. They don't mature and you aren't guaranteed of ever getting your principal back.

Stocks lose money during market crashes, too, and there have been many more market crashes than deflationary periods so I guess I still don't really understand your point. Do you think TIPS are more risky overall than stocks? Most people have diversified portfolios as different asset classes do well in different economic times. I don't think anyone here is recommending 100% TIPS, but they do help save the day during high inflationary periods like we are in right now, which was the point in the Swedroe article.

If you are very concerned about prolonged deflation, then TIPS may not be a good choice for your portfolio. However, we have been more concerned about the possibility of inflation eroding the value of our investments in retirement ourselves - "Deflation rarely occurred in the second half of the 20th century. In fact, the dramatic and consistent price increases from 1950 to 2000 has been unparalleled since the founding of the country." https://www.investopedia.com/ask/an...re-any-periods-major-deflation-us-history.asp

I don't disagree with you about any of the above - and agree that inflation is a far more serious and likely risk for retirees than deflation. Dr. Bernstein covers all of this very well in his book "Deep Risk." I'm merely pointing out that TIPS (unlike regular Treasuries) aren't likely to help during a market crash - while also admitting that we're in uncharted waters with bonds altogether, with interest rates so low across the board and the 40 year bull market apparently at an end.

I'll also share this comment from one of the best financial analysts I've come across:

"In the inflation discussion, I suspect comparing how TIPS responded to "unexpected inflation" has some built-in data availability bias as there has been only very minor inflation since they were first invented. We really don't know how they would have reacted to the double-digit inflation of the 1970s compared to nominal bonds with much higher rates set by market sentiment for that same inflation. And of course TIPS are subject*to the same rise and fall due to capital appreciation, and their inflation adjustment is really only guaranteed when you hold them*all the way to maturity.

Regarding 2008, while some would argue that the drop was a one-time thing caused by Lehman I would argue that the same event is evidence that the TIPS market is not liquid enough to do its job in a financial crisis. Which isn't exactly a feature."

 

[daylatedollarshort]

I don't disagree with you about any of the above - and agree that inflation is a far more serious and likely risk for retirees than deflation. Dr. Bernstein covers all of this very well in his book "Deep Risk." I'm merely pointing out that TIPS (unlike regular Treasuries) aren't likely to help during a market crash - while also admitting that we're in uncharted waters with bonds altogether, with interest rates so low across the board and the 40 year bull market apparently at an end.

I'll also share this comment from one of the best financial analysts I've come across:

"In the inflation discussion, I suspect comparing how TIPS responded to "unexpected inflation" has some built-in data availability bias as there has been only very minor inflation since they were first invented. We really don't know how they would have reacted to the double-digit inflation of the 1970s compared to nominal bonds with much higher rates set by market sentiment for that same inflation. And of course TIPS are subject*to the same rise and fall due to capital appreciation, and their inflation adjustment is really only guaranteed when you hold them*all the way to maturity.

Regarding 2008, while some would argue that the drop was a one-time thing caused by Lehman I would argue that the same event is evidence that the TIPS market is not liquid enough to do its job in a financial crisis. Which isn't exactly a feature."

Yes, TIPS only work as promised if you buy individual bonds and hold them to maturity. The TIPS "market" doesn't really matter if you don't buy and sell on the secondary market. And of course it is possible nominal bonds may do better at times. People don't buy TIPS to get rich, they buy them to stay rich. If you have a 4% withdrawal rate + lose 8.5% to inflation + lose 20% of your portfolio a year for a few years due to market loses in retirement, those compounded loses will be hard to ever recover from.

We know how TIPS will react to double digit inflation because that is a set feature of the bonds. They will increase with inflation, at least CPI stated inflation, plus earn the yield portion.

We don't know in advance how they will do in double digit inflation compared to nominal bonds and stocks because we don't know in advance how nominal bonds and stocks will do in general with double digit inflation. Nominal bonds may do great if inflation is 10% but interest rates are 15%. Yes, they certainly will do better then with a 5% real yield than 1% real yield TIPS. It is the real yield that counts. Stocks, or some sectors of stocks, may also go up during high inflation and do better than TIPS. TIPS are more for insurance, not to grow your portfolio by huge amounts, or make the highest possible return.

 

[OldShooter]

Yes, TIPS only work as promised if you buy individual bonds and hold them to maturity. The TIPS "market" doesn't really matter if you don't buy and sell on the secondary market. ...
People don't buy TIPS to get rich, they buy them to stay rich. ....

Exactly. When we bought our stash in 2007 we just bought the longest, lowest coupon available. At that time it was the 2s of 26. We didn't care a bit about the TIPS yield curve.

William Bernstein on investing for retirement: “Make no mistake about it: The object of this particular game is not to get rich – It’s to not get poor.”

 

[Magus]

Yes, TIPS only work as promised if you buy individual bonds and hold them to maturity. The TIPS "market" doesn't really matter if you don't buy and sell on the secondary market.

I've personally never liked the "hold to maturity and you never lose" argument with bonds, especially longer duration (>7 year) bonds. The same could be said about stocks. If I need the cash, I'll take a loss when I sell if the value has dropped in the market, just like with stocks.

I-Bonds I just lose the last three months of interest at the worst (or nothing after 5 years) with no risk of losing principal. Downside of i-bonds of course is the ability to really scale them with a larger NW, especially in a shorter period of time.

 

[daylatedollarshort]

Exactly. When we bought our stash in 2007 we just bought the longest, lowest coupon available. At that time it was the 2s of 26. We didn't care a bit about the TIPS yield curve.

William Bernstein on investing for retirement: “Make no mistake about it: The object of this particular game is not to get rich – It’s to not get poor.”

One of my light bulb moments came from reading Against the Gods: The Remarkable Story of Risk and the idea of diminishing marginal returns. Making more money wouldn't increase our happiness by much compared to the thought of losing a big chunk of our portfolio in retirement, either to market loses or inflation or both.

 

[daylatedollarshort]

I've personally never liked the "hold to maturity and you never lose" argument with bonds, especially longer duration (>7 year) bonds. The same could be said about stocks.

You can say the same thing about stocks but it would be incorrect. The government doesn't guarantee it will buy your stocks back at par value in a specified number of years, as is the case with individual Treasury or TIPS bonds.

 

[Magus]

You can say the same thing about stocks but it would be incorrect. The government doesn't guarantee it will buy your stocks back at par value in a specified number of years, as is the case with individual Treasury or TIPS bonds.

While theoretically true on paper, in reality over a long period of time a wide basket of stocks have arguably the same risk as government bonds but far more upside and debatably less risk since not as much inflation risk ( or deflation risk with tips). If you buy a 20 or 30 year gov bond and the S&P is still below where it is in 20-30 years than it is today, the probability the US government can’t service its debts is actually fairly high. At 120% of GDP today not even counting unfunded liabilities which are way worse today than a few decades ago, it’s not like it was in the 70s at 30-40% of GDP.

And my main point is if you need the cash between now and then regardless how you feel personally about that debt you can get way less than you paid for it and lose principal, likely when you need it most. Keep those durations reasonable until real yields are strongly positive - and I don’t mean yields on the hope inflation drops to 3% in 12 months. I mean current yield - current inflation.

 

[daylatedollarshort]

While theoretically true on paper, in reality over a long period of time a wide basket of stocks have arguably the same risk as government bonds but far more upside and debatably less risk since not as much inflation ( or deflation risk with tips). If you buy a 20 or 30 year gov bond and the S&P is still below where it is in 20-30 years than it is today, the probability the US government can’t service its debts is actually fairly high. At 120% of GDP today not even counting unfunded liabilities which are way worse today than a few decades ago, it’s not like it was in the 70s at 30-40% of GDP.

And my main point is if you need the cash between now and then regardless how you feel personally about that debt you can get way less than you paid for it and lose principal, likely when you need it most. Keep those durations reasonable until real yields are strongly positive - and I don’t mean yields on the hope inflation drops to 3% in 12 months. I mean current yield - current inflation.

I replied to your post where you said, "I've personally never liked the "hold to maturity and you never lose" argument with bonds, especially longer duration (>7 year) bonds. The same could be said about stocks." Being able to redeem bonds for par at maturity has nothing to do with stocks or GDP. And no one here has recommended buying long term bonds for money they may need in the short term. Many here who buy individual bonds use the ladder concept and invest for the long term with different maturity dates being the rungs in a ladder.

 

[Magus]

I replied to your post where you said, "I've personally never liked the "hold to maturity and you never lose" argument with bonds, especially longer duration (>7 year) bonds. The same could be said about stocks." Being able to redeem bonds for par at maturity has nothing to do with stocks or GDP. And no one here has recommended buying long term bonds for money they may need in the short term.

I’m not sure what you are arguing here - my point you highlighted is exactly the main point i was trying to get across. If you need to sell bonds are not a safe Harbor and the longer the duration the worse the risk. And actually it does have to do with GDP - you assume bonds will always be paid out but that assumes the lender can pay. If we go 30 years with the markets still at the same level, it’s likely IMO the US government will default on its debt, either directly or indirectly through printing so yes they are related.

Bonds have greatly benefited the last 40 years of declining rates and we’ve never had a period of bonds in the US having negative real rates like we have the last few years. I think bond investors, IMO, are way to complacent, even more so than equity.

 

[eytonxav]

I remember back in the early 80s and my mortgage interest rate being ~ 14+ %, then in the 2003 timeframe when I was considering taking an early retirement package, I felt the interest rates would never go lower making my lump sum look attractive at that time, little did I know. Now after years of these low rates, I assumed probably I will not see higher rates in my lifetime, LOL. While rates are not significantly higher yet, they will most likely increase strongly as the year goes on. Just goes to show, if you wait long enough, what you thought will never happen does happen.

 

[ncbill]

I remember back in the early 80s and my mortgage interest rate being ~ 14+ %, then in the 2003 timeframe when I was considering taking an early retirement package, I felt the interest rates would never go lower making my lump sum look attractive at that time, little did I know. Now after years of these low rates, I assumed probably I will not see higher rates in my lifetime, LOL. While rates are not significantly higher yet, they will most likely increase strongly as the year goes on. Just goes to show, if you wait long enough, what you thought will never happen does happen.

The answer is:

you should have retired in the early 1980s & bought 30-year Treasuries.

 

[Gearhead Jim]

(subscribed)

 

[eytonxav]

The answer is:

you should have retired in the early 1980s & bought 30-year Treasuries.

If I was retirement age back then and know what I know now, yes indeed!