TIPS as Short Term Inflation Protection

[Closet_Gamer]

Hi.

DW and I plan to buy a beach house next fall, so I'm stock pilling money for a down payment.

With inflation running, figuring out what to do with money that is explicitly set aside for shorter term needs is a conundrum. (I've posted on that overall question before, don't want to rehash that here.)

Specific Question: Are TIPS (or TIP Funds) a good short-term inflation protection?

I don't know enough about the payment/inflation calculation structure of the security to understand if it really provides short term protection or if its more of a long-term protection?

If I bought $1000 of SCHP (Schwab TIPS fund), is it a fair bet that it would be worth $1000+inflation in 12 months?

What about specific TIPS issues maturing in 12 months?

Thanks for any insights.

 

[njhowie]

SCHP has an average maturity of 8 years, so I'd be classifying it more as a medium term fund rather than short term.

If I bought $1000 of SCHP (Schwab TIPS fund), is it a fair bet that it would be worth $1000+inflation in 12 months?

The key word in that statement is "bet". You are making a calculated bet. Maybe it plays out and you make a little money, maybe you bet wrong and it's worth less in 12 months.

Remember, you're buying a fund and the value of the TIPS holdings might go down depending on inflation outlook as time passes. Again - average maturity is 8 years.

Though it's a nice thought that you might be able to make an extra 3% to 5% (less taxes) on the money being stock piled, are you prepared that it could go down by that amount?

For money that you're looking for a very safe place, being needed in 12 months, don't "bet".

 

[Out-to-Lunch]

I believe that I understand the essence of your question, but I also do not know the answer to it!

However, in light of njhowies first comment, let me point out that there is a Vanguard short-term TIPS fund VTAPX (or the EFT version, VTIP). Its average duration is 2.6 years.

 

[Closet_Gamer]

Thanks both.

I'm explicitly seek to avoid volatility...just trying stay in front of inflation over the next 12 months.

Yes, SCHP is definitely more medium term. I would have to use a short term fund at Out-to-Lunch suggests. Or buy specific bonds with short maturities.

Its just kind of interesting that if inflation is running 3-4%, then an inflation protected bond should in theory be paying that over the next year. But I'm guessing the expectation is already priced in. And I believe there is some complexity to when/how TIPS actually pay the inflation component that I need to research.

 

[njhowie]

Its just kind of interesting that if inflation is running 3-4%, then an inflation protected bond should in theory be paying that over the next year. But I'm guessing the expectation is already priced in. And I believe there is some complexity to when/how TIPS actually pay the inflation component that I need to research.

Ah, but what are interest rates? Although inflation might be 3% to 4%, the one year TIPS bond is going to be priced in the market to return not what the inflation rate is going to be, but the interest rate. Meaning the price of the bond is going to be more expensive.

 

[Chuckanut]

I'm explicitly seek to avoid volatility...just trying stay in front of inflation over the next 12 months.

Given the 5%+ inflation we are currently seeing, that is a mighty big task, IMO.

I recall the inflation of the 70's and 80's. Even with Treasury Bill, notes and bonds at or near double digits people were still falling behind inflation.

Investing in risky things like junk-bonds, Krugerrands, gold, collectable coins, art, Swiss francs, aging scotch whiskey, various bonds denominated in foreign currencies, etc. turned out for most to be a poor way to fight inflation.

IIRC, all of the above were recommended by very confident self described 'experts' as a way to fight inflation way back then, and to protect yourself from the soon to be nearly worthless dollar. Yeah. Right.

My 2¢. Take what you wish and leave the rest.

 

[Out-to-Lunch]

Ah, but what are interest rates? Although inflation might be 3% to 4%, the one year TIPS bond is going to be priced in the market to return not what the inflation rate is going to be, but the interest rate. Meaning the price of the bond is going to be more expensive.

Good explanation. That jostled one of my remaining synapses: For the OP, TIPS will protect you from unexpected inflation, but not anticipated inflation.

 

[JT90505]

Good explanation. That jostled one of my remaining synapses: For the OP, TIPS will protect you from unexpected inflation, but not anticipated inflation.

TIPS protect against inflation measured by CPI-U (which may not match the inflation you personally experience.). It does not matter whether the inflation was expected or unexpected.

If you buy a TIPS bond and hold it to maturity you will know the real return of the holding when you buy it. In the most recent auction the real return for a 5 year TIPS was ~-1.685% (negative 1.685%), whether the inflation was expected or unexpected. TIPS purchased in the secondary market will quote a real return (assuming bond held to maturity) as well.

Buying a TIPS fund (or selling a bond before maturity) introduces interest rate risk. No different from 'regular' bonds, if interest rates go up, value of the bond goes down. So if you buy a TIPS fund and interest rates go up, it will impact the value of your holdings negatively.


While I'm extremely comfortable holding actual TIPS in a tax deferred account and have some taxable money in short term TIPS fund, I can't say they are (or are not) a good place for your funds. I suggest you do some research to get an understand of TIPS pricing so you can evaluate the risks for your situation.

 

[SecondAttempt]

Hi.

DW and I plan to buy a beach house next fall, so I'm stock pilling money for a down payment.

With inflation running, figuring out what to do with money that is explicitly set aside for shorter term needs is a conundrum. (I've posted on that overall question before, don't want to rehash that here.)

Specific Question: Are TIPS (or TIP Funds) a good short-term inflation protection?

I don't know enough about the payment/inflation calculation structure of the security to understand if it really provides short term protection or if its more of a long-term protection?

If I bought $1000 of SCHP (Schwab TIPS fund), is it a fair bet that it would be worth $1000+inflation in 12 months?

What about specific TIPS issues maturing in 12 months?

Thanks for any insights.

I'll let others comment specifically on TIPS but I think you might want to think about this a little differently. Your need is not to protect against general inflation. Your goal is to protect against inflation in the price of beach houses. That's quite different but you might be able to do so by buying a residential REIT.

 

[daylatedollarshort]

n the most recent auction the real return for a 5 year TIPS was ~-1.685% (negative 1.685%), whether the inflation was expected or unexpected.

I don't know what expected or unexpected inflation means. The real return will be inflation (5.9%) + the yield (-1.685). So maybe they are still not a bad deal compared to 5 year CD rates.

 

[Out-to-Lunch]

TIPS protect against inflation measured by CPI-U (which may not match the inflation you personally experience.). It does not matter whether the inflation was expected or unexpected.

If you buy a TIPS bond and hold it to maturity you will know the real return of the holding when you buy it. In the most recent auction the real return for a 5 year TIPS was ~-1.685% (negative 1.685%), whether the inflation was expected or unexpected. TIPS purchased in the secondary market will quote a real return (assuming bond held to maturity) as well.

By "protect," I meant as opposed to holding nominal bonds. That is, consider twins, one of whom buys nominal Treasuries, and the other buys TIPS, and they hold them for some period of time. If inflation proceeds as expected when they made the purchase, each twin has about the same spending power at the end of the period. If, on the other hand, inflation unexpectedly skyrockets, the twin holding TIPS is in a better position than the twin holding nominals. (Of course, if inflation is lower than expected, then the reverse is true.)

Edit: cf. https://www.bogleheads.org/forum/viewtopic.php?t=260274

 

[JT90505]

By "protect," I meant as opposed to holding nominal bonds. That is, consider twins, one of whom buys nominal Treasuries, and the other buys TIPS, and they hold them for some period of time. If inflation proceeds as expected when they made the purchase, each twin has about the same spending power at the end of the period. If, on the other hand, inflation unexpectedly skyrockets, the twin holding TIPS is in a better position than the twin holding nominals. (Of course, if inflation is lower than expected, then the reverse is true.)

Edit: cf. https://www.bogleheads.org/forum/viewtopic.php?t=260274

agree. If actual inflation matches breakeven inflation rate at the time you purchase a bond it does not matter whether you buy nominal or inflation protected bonds (and hold to maturity).

 

[JT90505]

I don't know what expected or unexpected inflation means. The real return will be inflation (5.9%) + the yield (-1.685). So maybe they are still not a bad deal compared to 5 year CD rates.

I'll do my best to answer your question, keep in mind I am not an expert and you need to do your due diligence. I'll use 5 year TIPS and Treasuries/CD's as examples.

In short, if inflation exceeds ~2.9% over the next 5 years, the 5 year TIPS is better than a 5 year CD or treasury. Conversely, if inflation is less than ~2.9% you would be better off holding the CD or treasury. Why?

The most recent TIPS auction resulted in a real (inflation adjusted) return of approximately negative 1.7%.

Current 5 year CD's and treasuries pay a nominal (not inflation adjusted) yield of about 1.2%.

The difference between the nominal (Treasuries) and real (TIPS) is the breakeven (or expected) inflation rate. If inflation is 2.9% over the next 5 years, the real yield of the treasury is the yield 1.2% - inflation 2.9%, or negative 1.7%...matching the real yield of the TIPS.

So if you believe over the next five years inflation will be 5.9% (unexpectedly high inflation), yes a TIPS bond will be a much better investment. If there is unexpectedly low inflation, the CD would have a better return.

What the market is saying is that although current inflation is high, the market believes inflation is transitory and over the next five years the overall inflation rate will be ~2.9% (expected inflation).

BUT, if you buy a TIPS ETF or mutual fund, or sell the bonds before maturity, interest rates will either improve your total return or make it worse. Similar to a 'traditional' bond fund. If interest rates go up, the price of the bond goes down (and vice versa). The price of TIPS funds are also affected by ever changing inflation expectations and the duration of the bond holdings...there are multiple moving parts.

 

[daylatedollarshort]

So if you believe over the next five years inflation will be 5.9% (unexpectedly high inflation), yes a TIPS bond will be a much better investment. If there is unexpectedly low inflation, the CD would have a better return.

Okay, I should have said the total return, based on the current 5.9% inflation. I have not bought TIPS in the past at negative yields. But our personal inflation rate seems pretty low, and at 5.9% inflation even with a negative yield the total return isn't looking too bad right now compared to the fixed alternatives for the same time frame. Looking 5 years out, it doesn't seem like the worker shortage is going to ease up anytime soon and that seems to be a part of the current inflation rate driver.

 

[njhowie]

Looking 5 years out, it doesn't seem like the worker shortage is going to ease up anytime soon and that seems to be a part of the current inflation rate driver.

One good recession and the worker shortage will be history.

 

[daylatedollarshort]

One good recession and the worker shortage will be history.

Stocks go down in a recession, too. There is no one size fits all investment asset class, unless you can predict the future with 100% accuracy. I don't think anyone here is going 100% all in on new TIPS at the current rates. Just taking best guesses and calculated risks, with diversified portfolios.

 

[JT90505]

daylate,

you can only buy 10K per person per year, but have you considered I-Bonds?

agree with your most recent post (diversified portfolios)

 

[daylatedollarshort]

daylate,

you can only buy 10K per person per year, but have you considered I-Bonds?

agree with your most recent post (diversified portfolios)

Yes, we have been discussing maxing out I-bonds this year, plus gift some to our adults kids to give them a little early inheritance and increase the family maximum puchase limit.

 

[sengsational]

Just take the money and buy the "beach house" today via an REIT (presuming you can find one that's not too expensive fee-wise, and that matches the market you're going to be buying into). Your target priced house * pct down payment into the REIT will mean that you can liquidate and hit the down payment in the fall, irrespective of inflation.