Which Asset Classes Protect Against Inflation by Larry Swedroe

[kevink]

Worthwhile article by Larry Swedroe:

https://www.advisorperspectives.com/articles/2022/04/25/which-asset-classes-protect-against-inflation

Not a whole lot of safe places to hide for the average investor it would seem. Diversifying equities seems to help (value doing "less worse" than growth, for example), even though (contrary to popular belief) equities aren't a good hedge against inflation except over very long periods (longer than the lifespan of a typical retiree or ever early retiree).

He does cite TIPS as one of the best options - WHEN their real yield is positive, which it isn't now. Seems to me there just isn't enough history (they've only been in existence in the U.S. for 25 years and have performed poorly during market crashes) for him to be so confident.

Easy to see why money is flowing into real estate and iBonds though.

 

[Magus]

Easy to see why money is flowing into real estate and iBonds though.

Yup

“Although the relationship is not perfect, real estate has been a good hedge against inflation. In particular, residential real estate values tended to rise with incomes.“

It’s why I’ve gone way overweight on RRE the last two years and purchased as much I bonds as I can.

 

[jim584672]

I would think commodities would be a hedge. Just don't know how to play that angle.

 

[arcyallen]

I'm not sure where he came to the conclusion that equities weren't a good hedge against inflation. Yes, in the short term equities can always be a volatile investment but over longer periods of time (shorter than a lifespan!) they've done fantastically well keeping pace with everything short of hyperinflation.

 

[OldShooter]

... He does cite TIPS as one of the best options - WHEN their real yield is positive, which it isn't now. Seems to me there just isn't enough history (they've only been in existence in the U.S. for 25 years and have performed poorly during market crashes) for him to be so confident. ...

People just don't understand TIPS.

As we retired in 2006/2007 we bought a boatload of TIPS. We felt that the only real threat to our long-term retirement was a return of high inflation; the TIPS were our insurance policy. Still are, in fact. At that time, I viewed the yield penalty vs govvies to be an insurance premium paid for inflation insurance. Still do. I expected that, if we started to see high inflation, that the TIPS would be bid up by people who were afraid for the future and hence willing to take low or even negative YTM numbers in exchange for protection. That seems to be the case now.

The typical YTM number understates the real yield of TIPS because it necessarily assumes no inflation forward from the day the calculation is made. That fact contributes to a lot of confusion.

IMO worrying about negative YTM numbers is silly. The numbers are all part of an investment decision: Is the net of the real YTM and future inflation protection better than whatever actual alternative investment one might make? I think all the angst about negative returns stems from humankind's baked-in loss loss aversion, described by Doctors Thaler and Kahneman. It's just numbers, folks; no emotions needed.

Re "history" the USG has been paying its bills for two or three hundred years; not sure why that is not enough history. The only uncertainty is the degree to which inflation-panicked buyers will bid the prices up or whether things will calm down. Either way, we will have collected the inflation increases on our TIPS face values, we'll be getting paid interest on that growth, and we'll still have the TIPS for future inflation insurance. If the current price goes down, which it may well do if inflation moderates, we don't care. Prices have been going up and down for 15 years and that's been fine with us.

Due to the gummint taxing the inflation increases, TIPS are not the perfect hedge, but inflation increases in other assets are taxed, too. So government-guaranteed protection seems pretty attractive.

 

[Montecfo]

^^^ For most people I think the premium has been too large to be worth it. Most people DO care about the return.

But that does not mean it is not right for you or others, circumstances depending.

 

[razztazz]

I'm not sure where he came to the conclusion that equities weren't a good hedge against inflation. Yes, in the short term equities can always be a volatile investment but over longer periods of time (shorter than a lifespan!) they've done fantastically well keeping pace with everything short of hyperinflation.

I'll reiterate this point. I don't know if it's a quote directly from the article or the OP's words but it's true. equities aren't a good hedge against inflation except over very long periods (longer than the lifespan of a typical retiree or ever early retiree).

When people say "hedge against inflation" the implication is: They do well contemporaneously as a direct result of inflation. Stocks can do poorly to absolutely prohibitively against inflation.
​

 

[razztazz]

I would think commodities would be a hedge. Just don't know how to play that angle.

I think it's a site called Portfolio Charts. The one with the precanned asset allocations depicted as donut looking charts. Somewhere in that site (last I was there years ago) there was a section where you could build your own asset allocation "donut." Because my only concern is inflation and having enough money, not making every last possible theoretical penny, I tried to build something that would in effect defeat inflation and have no "red squares" on the heat map.

Initially I loaded up with gold (10-20% I believe). Hey worked like magic!! Then I tried real estate, then commodities. Boo! Performed poorly. Like, shockingly poor. And these are the things "They" keep telling us are good against inflation. The same people who "don't know nuthin'"....?

Other than TIPS/I-bonds or just staying in cash and at least keeping the ballgame close for a few years via CDs or MMfs, you can't trust anything to help much in inflationary times.

And gold isn't or might not be what it used to be. Somewhere on this Forum is a thread talking about how the magic of Gold vs inflation was a freak one-time event caused by going off the gold standard just as inflation was surging and that cannot happen again. (possibly from an article at Early Retirement Now...?) I am not a man of the cloth when it comes to gold, however.

 

[steelyman]

People talk about Harry Browne’s “Permanent Portfolio”. I dipped into it through PRPFX but sold long ago.

https://en.m.wikipedia.org/wiki/Fail-Safe_Investing

 

[daylatedollarshort]

People just don't understand TIPS.

There is a lot of of excitement right now for 0% real yield I-bonds on this forum with their $20K annual caps, yet not so much praise and glory for TIPS with positive yields for 20 - 30 years, which one can buy right now in unlimited quantities. I'm excited for what the TIPS real yields, which are heading up, will be later in the year. We plan to buy more TIPS when rates top out later this year or next, which should be 1 - 2% real yields, then live off that real yield, plus pensions and SS.

A 4% withdrawal rate, losing 8.5% to inflation, plus possibly losing another 5 - 50% money in bond or stock funds seems like it would deplete a portfolio pretty fast.

 

[Magus]

I think it's a site called Portfolio Charts. The one with the precanned asset allocations depicted as donut looking charts. Somewhere in that site (last I was there years ago) there was a section where you could build your own asset allocation "donut." Because my only concern is inflation and having enough money, not making every last possible theoretical penny, I tried to build something that would in effect defeat inflation and have no "red squares" on the heat map.

Initially I loaded up with gold (10-20% I believe). Hey worked like magic!! Then I tried real estate, then commodities. Boo! Performed poorly. Like, shockingly poor. And these are the things "They" keep telling us are good against inflation. The same people who "don't know nuthin'"....?

Other than TIPS/I-bonds or just staying in cash and at least keeping the ballgame close for a few years via CDs or MMfs, you can't trust anything to help much in inflationary times.

And gold isn't or might not be what it used to be. Somewhere on this Forum is a thread talking about how the magic of Gold vs inflation was a freak one-time event caused by going off the gold standard just as inflation was surging and that cannot happen again. (possibly from an article at Early Retirement Now...?) I am not a man of the cloth when it comes to gold, however.

Real estate does really well actually in those scenarios, just not public market REIts which are significantly more volatile than private market transactions and cash flow and generally have more leverage to boot, plus get multiple expansion and contract like the market. Private real estate transactions are based usually on cap rates. Blackstone is the king of taking advantage of the public/ private dichotomy of assets underpriced in public markets early in a cycle and overpriced mid/late cycle vs private markets.

Private market really estate is vastly larger than public REITs and public REITs woefully under present RRE which is the most stable real estate in recessions historical because rents are extremely sticky (dropped just 2% briefly nationally in 2008-09). Look up at how real estate performed from 1975 to 1983 - home run across the board.

 

[Magus]

There is a lot of of excitement right now for 0% real yield I-bonds on this forum with their $20K annual caps, yet not so much praise and glory for TIPS with positive yields for 20 - 30 years, which one can buy right now in unlimited quantities. I'm excited for what the TIPS real yields, which are heading up, will be later in the year.

That's because the cost to acquire those TIPs is way over par now, putting their nominal and real yield well below that of i-bonds in the short term. If people could buy TIPs at par today, most would be happy to do so. But the real yield on TIPs purchased today is closer to 3% on YTM.

 

[daylatedollarshort]

That's because the cost to acquire those TIPs is way over par now, putting their nominal and real yield well below that of i-bonds. If people could buy TIPs at par today, most would be happy to do so. But the real yield on TIPs purchased today is closer to 3% on YTM.

I don't really understand your post. If I could get a 3% real yield on TIPS I'd be thrilled. The 20 - 30 years have slightly positive yields right now - United States Rates & Bonds - Bloomberg.

ETA - Do you mean TIPS funds are losing money? That is different than a ladder and holding the bonds to maturity.

 

[razztazz]

Real estate does really well actually in those scenarios, just not public market REIts which are significantly more volatile than private market transactions and cash flow and generally have more leverage to boot. Blackstone is the king of taking advantage of the public/ private dichotomy of assets underpriced in public markets early in a cycle and overpriced mid/late cycle vs private markets. Private market really estate is vastly larger than public REITs and public REITs woefully under present RRE which is the most stable real estate in recessions historical because rents are extremely sticky (dropped just 2% briefly nationally in 2008-09). Look up at how real estate performed from 1975 to 1983 - home run across the board.

That might be why the home-made Portfolio Charts AA flopped with RE. I would assume (because it's the most accessible retail investor's interface) that their RE numbers came from perhaps a composite REIT index of some kind. And I know commodities are so volatile the only real way to make money with them is buy today sell tomorrow. (Like the evil billionaire in an old movie trying to corner the black pepper market) If you just buy and hold there's no telling where it'll be down the road. I looked into that back in the 80's. I felt I had done better when I lived in Vegas.

 

[Sunset]

That's because the cost to acquire those TIPs is way over par now, putting their nominal and real yield well below that of i-bonds in the short term. If people could buy TIPs at par today, most would be happy to do so. But the real yield on TIPs purchased today is closer to 3% on YTM.

Ouch....
Is there ever a time a regular Joe can buy TIPs at the face value ?

 

[OldShooter]

There is a lot of of excitement right now for 0% real yield I-bonds on this forum with their $20K annual caps, yet not so much praise and glory for TIPS with positive yields for 20 - 30 years, which one can buy right now in unlimited quantities. ...

For good reason. Those I Bonds are a fantastic deal. I would be all over them if the quantity limits weren't so low.

Ouch.... Is there ever a time a regular Joe can buy TIPs at the face value ?

The key to TIPS being expensive is inflation fears. Back in 2006 inflation was quiet and IIRC we paid pretty close to par for the 2%/2026s that we bought. IMO not many people take the long view with TIPS. People seem to be mesmerized by current yield, almost totally forgetting the inflation hedge. If we get a 10 year thrill ride like this:

​

I think attitudes will begin to focus on the hedge aspect.

Different editorial: I just cock my head when I read of someone having a 5% TIPS position. So what? How is that worthwhile inflation protection? Regardless of what investment you choose for inflation protection, I think the rule has to be "Go big or go home." IMO a 5% position is no position at all.

 

[pb4uski]

There is a lot of of excitement right now for 0% real yield I-bonds on this forum with their $20K annual caps, yet not so much praise and glory for TIPS with positive yields for 20 - 30 years, which one can buy right now in unlimited quantities. I'm excited for what the TIPS real yields, which are heading up, will be later in the year. We plan to buy more TIPS when rates top out later this year or next, which should be 1 - 2% real yields, then live off that real yield, plus pensions and SS.

A 4% withdrawal rate, losing 8.5% to inflation, plus possibly losing another 5 - 50% money in bond or stock funds seems like it would deplete a portfolio pretty fast.

Yes, it looks like TIPS yields are improving with the 2040 maturity trading slightly positive in real terms (+0.207).

To be fair though, many who are buying today's ibonds are doing so because even if you keep them the minimum of 1-year and accept the early withdrawal penalty the yields are still better than short term CDs or UST.... they are not necessarily in them for the long haul but more as a substitute for CDs or USTs. For me, if the yields remain attractive compared to CDs and UST's I'll stick with them.

2050-2052 maturities with negligible coupons (+0.125-+0.250) are trading at less than 100... mid to high 90s.

 

[Chuckanut]

For good reason. Those I Bonds are a fantastic deal. I would be all over them if the quantity limits weren't so low.

The key to TIPS being expensive is inflation fears. Back in 2006 inflation was quiet and IIRC we paid pretty close to par for the 2%/2026s that we bought. IMO not many people take the long view with TIPS. People seem to be mesmerized by current yield, almost totally forgetting the inflation hedge. If we get a 10 year thrill ride like this:

​

I think attitudes will begin to focus on the hedge aspect.

Different editorial: I just cock my head when I read of someone having a 5% TIPS position. So what? How is that worthwhile inflation protection? Regardless of what investment you choose for inflation protection, I think the rule has to be "Go big or go home." IMO a 5% position is no position at all.

OldShooter, sometimes I think you and I are almost the only people on this site who lived through that roller coaster ride. IIRC, it took nearly two decades for the US market to recover on a real basis from 1974. Not so good.

FWIW, I asked my Congress person to support raising the I Bond max to 50k as a way to help the middle class. I’ll let you know if and when I get a reply. I’m not holding my breath.

 

[arcyallen]

I'll reiterate this point. I don't know if it's a quote directly from the article or the OP's words but it's true. equities aren't a good hedge against inflation except over very long periods (longer than the lifespan of a typical retiree or ever early retiree).

When people say "hedge against inflation" the implication is: They do well contemporaneously as a direct result of inflation. Stocks can do poorly to absolutely prohibitively against inflation.
​

Maybe we're talking about two different things, but I don't think so. Can you point out a 15 year period that stocks didn't outpace inflation? Not a lifespan of a person, but just 15 years? Year to year, I agree there's no solid correlation. But over the course of a decade (and ofte less) stocks -do- keep pace with inflation.

 

[foxfirev5]

FWIW, I asked my Congress person to support raising the I Bond max to 50k as a way to help the middle class. I’ll let you know if and when I get a reply. I’m not holding my breath.[/QUOTE]

Another reason why I leave a decent amount of cash on hand. Nobody knows what may happen. Recent Gov't giveaways are always in play.

 

[razztazz]

Maybe we're talking about two different things, but I don't think so. Can you point out a 15 year period that stocks didn't outpace inflation? Not a lifespan of a person, but just 15 years? Year to year, I agree there's no solid correlation. But over the course of a decade (and ofte less) stocks -do- keep pace with inflation.

1) Really doesn't matter here. Historically inflation hasn't been more than a pin-point problem usually reclaimed by an ensuing bust. Now that it is practically a canon of economics you have to start that clock circa 1965-ish and we are only now possibly swinging back in that direction. IOW there's no reason to have any unwarranted/undemonstrated faith in stocks as a hedge.

2) 15 years might be the remaining lifespan of any theoretical investor as I read Swedroe's statement. So we don't have to talk about 30 years. I don't think he's assuming problems with inflation means high inflation on DAY#1 then + 30 years.

3) Just because stocks have maybe just inched ahead of inflation (hardly a ringing endorsement and not much of an investment in my book) after what is at least half a lifetime, I wouldn't call that "A hedge against inflation." Barely succeeding in spite of inflation is not the same as benefiting from inflation. A hedge is what I indicated and what I hear when the mass of the investing community says "hedge." Something that is enhanced collaterally with and by inflation. That ain't stocks in anybody's book. Waiting beaucoup for something to "spring back and catch up." Yeah, Ok.

In 1966 the DJIA closed around 900 as it did in 1981. No gain & eaten up by the Hungry "I". The Inflation rate between those years was 6.89%. Dividends in the old days were about 4% (Altho I can't find a specific number for that timeframe.) A gold mine by today's standards but less than inflation. Doing some math I'm willing to bet that tipped red, and 1967 didn't look any better. https://studyfinance.com/inflation/us/1966/950/1981/


I wonder just how long the S&P took to catch up on an inflation adjusted basis. Somebody on CNBC said once it took into the 1990's but I've never tried to chase that one down.

 

[arcyallen]

In 1966 the DJIA closed around 900 as it did in 1981. No gain & eaten up by the Hungry "I". The Inflation rate between those years was 6.89%. Dividends in the old days were about 4% (Altho I can't find a specific number for that timeframe.)...
I wonder just how long the S&P took to catch up on an inflation adjusted basis. Somebody on CNBC said once it took into the 1990's but I've never tried to chase that one down.

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%.

 

[daylatedollarshort]

He does cite TIPS as one of the best options - WHEN their real yield is positive, which it isn't now. Seems to me there just isn't enough history (they've only been in existence in the U.S. for 25 years and have performed poorly during market crashes) for him to be so confident.

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.

 

[Closet_Gamer]

Interesting article...and I certainly haven't done any research into his data/assertions...but something doesn't intuitively make sense to me.

If equities have historically been the best performance asset class over medium to long periods and consumption/quality of life has generally been trending up ...

... how can the best performing asset class lag inflation over even a medium term?

Wouldn't this suggest that, absent an explicitly inflation-linked security like TIPS, its impossible to keep up with inflation over medium-to-long terms?

I don't think historically that's been true?

 

[target2019]

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.