Go with TIPs or am I crazy?

Mister Bill

Confused about dryer sheets
May 23, 2005
Long and short of it, the market stinks.  I've been early retired for several years and just don't want to spend my leisure time watching stocks go nowhere.

With a decent pension and covered medical insurance till Medicare kicks in, it looks like my withdrawal rate will be slightly below 2%.

But wait, currently TIPs yield 1.75% over inflation.  I realize that even the 30 year TIPs mature in 2028, but if I'm willing to take the risk that interest rates will drop in 23 years, what would be wrong with a retirement portfolio of 100% TIPs?

If inflation skyrockets, so will my rate of return.  If deflation hits, I'll still be guaranteed my principal and a little interest.

Please tell me what I'm missing.  (Just be kind about it.  The mother-in-law thinks I'm an idiot, just don't want to see confirmation on the internet.)
I say keep some equity exposure for growth (you won't have that with 100% debt securities). Dividends can rise with inflation too my friend. Yeah the market stinks but just about everything else does too. Feel better?
Actually tips offer a rate of return plus CPI, not necessarily inflation. As I've chronicled, CPI doesnt come close to measuring my own areas and my personal rate of inflation.

As chronicled by others, it also doesnt measure broad inflation very well at all either.

How it works for you depends on your personal rate of inflation, your areas rate of inflation, and your willingness to 'basket substitute' items that become too expensive. Burger for steak, boxed wine for vintage, etc.

Inflation skyrocketing wont skyrocket your rate of return, your rate of return will remain exactly the same, plus or minus any variance in CPI reporting vs actual.

The other bugaboo with TIPS is that you pay taxes on the CPI adjustment to your principal annually, although you do not get the adjustment until you cash in the bond. This may or may not be good for you, as your tax situation obviously will vary from the next guys.

I personally think a portfolio of 100% anything is a bad idea. Most measured analyses show that at least 20% of something else makes for higher returns and lower volatility. Even the vanguard stodgy target income and lifestrategy income include some stocks and a variety of bond types.

But yeah, tips will be nice to have if runaway inflation hits us. I personally dont think that it will, and if it does, CPI probably wont reflect it. Maybe there arent a lot of 'better' options, but I'll keep looking for one.
In the spirit of unnecessary multiple sequential posting, if you are skeptical about the equivalence of cpi and inflation, as someone you know who has been retired and living on social security for at least 10 years how their cpi-adjusted social security payments are doing vs their bills. My dad has been on social security for about that time period, and he says his money buys about 85-90% of what it used to. His cohorts at his Sun City feel about the same way.

That more or less meshes with Bill Gross's testimony that he feels the CPI understates actual broad inflation by ~1% a year.

Which wouldnt bother me if Greenspan didnt regularly say he thought CPI *overstates* inflation by 1% or more...you know whats coming...wait for it...
OK, a 100% portfolio of TIPs is not one of my better ideas.  What kind of percentage in stocks would be recommended.  In my case I would probably average into a very broad based mutual fund or an ETF like the Vipers (VTI).

I played with the FIRE-CALC calculator.   Looks like 50% to 60% equities yields the highest SWR just under 4%  (Assumed 2% TIPs yield, life of 40 years, and using the CPI calculation for inflation.)  Looks like another home run for Scott Burn's Couch Potato Portfolio.

My outlook for the market is flat for the next several years (at best) however I fear a slow but steady drop out till the year 2012.  Not saying this is correct, but modeling my portfolio around this scenario will allow me to sleep at night.  (Yeh, I missed the boom of the ninties, but I also sat out the bust of last several years.)

p.s. Looks like Mondays are good for posting questions.  Lots of excellent replies real fast.  Thanks.
I think VTI can be an excellent part of a good breakfast. I mean portfolio.
As can Vanguard's VPL, VWO, and VGK. And SHY or a Vanguard short term bond fund--or better yet IMO, ibonds (if in a taxable account).

My favorite investing book is Bernstien's The Four Pillars of Investing. It is a long read but well worth it, and gives great advice, including advice on building a portfolio.
Mister Bill, a 100% TIPS portfolio is an outstanding idea in your case. If you can maintain TIPS ladders at 1.75% (or do the equivalent by selling some TIPS along the way), you can withdraw 3.0% of your principal (plus inflation) for 50 years before running out of money.

This high withdrawal rate is because you would be drawing down principal. BUT, and some people fail to realize this fact, YOUR PRINCIPAL GROWS IN A WAY THAT MATCHES INFLATION.

The biggest problem is that taxes are due immediately on the adjustments to principal with TIPS. (Taxes are deferred with Ibonds.) If you have a tax sheltered account, go for it.

What about stocks and growth? Don't expect anything for the next decade or so. Stocks are still overvalued by a host of indicators. Unless you are tapping into a dividend income stream, stocks will be bad news over the intermediate term (of 5 to 20 years). The exact dates, etc., are uncertain and the year-to-year fluctuations will be up almost as often as down. The intermediate-term market direction is almost certainly down. There is always the possibility of another bubble. I would not count on it.

What if you stay away from stocks right now and their prices fall? You would be in an excellent position. You would still have around 75% to 80% of your principal remaining. With a TIPS ladder, you could reinvest some of the principal into attractively priced stocks.

Have fun.

John Russell
Mister Bill said:
p.s. Looks like Mondays are good for posting questions.

Is it monday? I hadnt noticed! ;)

Firecalc cant tell what the market is going to do, but if you think that equities are going to underperform (and I do as well), then underweighting those until you dont feel the same might be a good idea.

Historically, less than 20% equities caused lower portfolio returns without reducing volatility. More than 80% equities caused more volatility without increasing returns.

So something in the 20/80 to 80/20 range. As you noted, historically a 60/40 gave a good balance of return and volatility. I think you'll find most people in the 40/60 to 60/40 range. Some eschew bonds and dont mind the volatility and go with 80/20 to 100/0. I havent seen many of those without enormous portfolios or an alternate income stream to cover their costs during bad times.

Some go with all bond or high bond allocations (10/90-20/80). A lot of these folks factor in a date by which they expect to be deceased as such a port that isnt based on a huge amount of money will likely deplete within a period of time. I sort of have a problem with presuming I'll be dead by 80, as I might surprise myself in a bad way. A lot of these folks write books and 20-30 years later arent doing so well, as in Joe Dominguez' life in a group home washing out tin foil for the 100'th time and eating crap.

[Note, I see our old friend JWR1945 posted while I was writing this. JWR's 'calculations' have been pretty much debunked by a few hundred other early retirees. Proceed with caution. He thinks he has a crystal ball and can determine the future. His methodology would have kept you out of stocks during the last three bull markets...so much for that crystal ball...]

For nervous, conservative investors (and I was in that camp prior to procuring a 'nurse with a purse' last year), a 40/60 is not a bad balance. Something like a conservative lifestrategy fund or vanguards Wellesley fund offers excellent historical returns, a high dividend yield, and pretty easy volatility. You're not going for broke here, but you're not throwing out the baby with the bathwater either...
Since it's Monday and we're talking Viagra -(oops wrong thread).

If you wish to putz, indulge some male hormones and bet your scenario: Buy Vanguard Target Income - take out the current yield 3 - 4% or so - if stocks do as you predicted - jump to 2005, 2015 as the yield climbs past 4%.

BTY - Income series starts at 25% Inflation protected and drops as you climb backward up the series.

It really depends on how much you like to putz and er ah keep yours hands on the throttle so to speak.

A plain old as appropriate Wellesley(oops I did it again), Lifestrategy, Target Retirement and go do things other than investing can work just as well.
For Mister Bill: A correction.

After withdrawing 3.0% of your initial balance for 10 years, you would have 86.5% of your principal (plus inflation) with 1.75% TIPS, not 75% to 80%.

The formulas are straightforward. I treat TIPS as if they were mortgage payments and I were the lender. It all works out. The only thing special is that the interest rate and all of the dollar amounts are in real dollars (that is, they increase to match inflation).

I have included the formulas are in this article TIPS versus Dividends at my web site.

Have fun.

John Walter Russell
Come on, you don't know where prices are going. You can make an educated guess but that is all.

100% allocation is not a good idea and I think "You don't know me" has some good suggestions in terms of allocation for early retirees.  Some good dividend paying equity exposure will help out over the long-term.

Why not 100% and wait for your pitch/er ah buy - IF the 'decent pension' is sufficient.

Not me of course - but if someone had the patience of a Warren Buffett:confused:?

Why not?
My references are numerous.

John Mauldin makes similar predictions in Bulls Eye Investing. He presents at least half a dozen methodologies that all lead to the same conclusion.

Ed Easterling comes to the same conclusion in Unexpected Returns. If you don't want to buy his book, you can study the information at his web site. He presents all of the pieces.

Professor Robert Shiller of Yale, who wrote Irrational Exuberance, showed convincingly that P/E10 has predictive power in the intermediate-term.

Apply the Dividend Discount Model (or Gordon Equation), possibly using John Bogle's variant. The conclusion is the same.

Some of us talk in terms of probabilities. It is possible, but not likely, that a super-bubble will follow the bubble.

Have fun.

John Russell
Even if you have your references for your/their predictions why would you recommend 100% of anything? Poor allocation. Do any of your financial sources recommend that as an efficient portfolio? I seriously doubt it.

John Mauldin is an author and is trying to sell books so I immediately dismiss him

Most savy investors, including Warren the Great, that use the DDM and Gordon predict equity returns in the range of 6-7%, hardly as horrific as you make it sound.
OOh other people on the internet and who write books or sell newsletters think the same thing, so it MUST be true!

Hope your 100% tips allocation works out when CPI doesnt match inflation over 20-40 years, or when you arent dead when your money runs out.

As I mentioned above, had I followed the JWR strategy for the last ten years, my net worth would be approximately 10% of what it is, and I'd still be working. Even if I only went halfway into the "zero equities" because PE/10 said they were overpriced, I'd still be working.

Yep, equities are overpriced. I wouldnt be a huge buyer in the 80%+ range right now. I also acknowledge that neither myself, nor anyone else, is "mr investment wizard" and we dont know where different asset classes are headed.

Its possible we go sideways for 10 years. Or drop 50% tomorrow. Or keep going up 5-8% a year indefinitely. Thats why we employ good asset allocation and dont overthink it.

Because NOBODY knows where a particular asset class is going. Nobody has a system. No measurement is foolproof.

Now, riddle me this one...stocks drop a bit, inflation is tame, everyone wants to become a stock owner. What do you think you're going to get for your 1.75% tips on the secondary market when you sell them to triumphantly move into stocks? A lot less than what you paid for them.

Suffice to say I ditto YDKM and WC's comments.
Rats! - How come we never have a Norwegian widow zone?

How about - take 'the decent pension' amount times 25 - count that as fixed - And then see how much stock needs to be bought to put you on the efficient frontier curve - what's the split end up in the 20/80 to 80/20 range?

Yet another way to skin a cat.

Of course if everybody burns out - there's always kayaks.

Heh, heh, heh, heh.
Thats it...zero to kayak in 20 posts...we're off the mark a little bit, but still not bad for non-working stiffs...
A great tool in deciding how much of your portfolio to put into TIPs is at http://www.prenhall.com/worryfree/. It's an excel worksheet developed by Zvi Bodie, finance professor at Boston University. His argument (in his book Worry Free Investing) is that you should put just as much into TIPs as you need to cover your expected withdrawals. You can put the remainder into stocks and then if stocks do well, you can party, and if they do poorly at least you won't starve.

There's a lot to debate philosophically about the CPI, and I happen to agree with prior posters that the CPI probably will understate the actual inflation I'm going to experience as a retiree. But I also think that Bodie has a point that there's no inherent truth in the assertion that stocks, held for the long term, will always outpace inflation. Maybe they will, maybe they won't. So I'm all for not putting all your eggs in one basket. Still, a lot of my eggs are going to be in TIPs.
I am concerned that we might be headed into a period of slow
economic growth with rising inflation (stagflation). If that occurs,
it is not likely that stock dividends will keep pace with inflation,
IMHO. If anybody has contrary data, please post it.

Although your personal inflation rate may or may not be higher
than the official CPI, you at least get some protection with
TIPS, I-Bonds, and commercial CDs and bonds linked to the

In my case, most of my bond allocation is committed to intermediate
term bonds that pay CPI + 2% to 2.38%. These bonds are still
available on the secondary market at close to par value.

For what it's worth, I think the strategy of all your money in TIPS
could be OK for some people depending on your overall financial

However, in my case, I need about 4% from my investments
and for me a 50/50 allocation seems about right. After all, even
if the market muddles along at 6-8% per year thats a little better
than we should expect from bonds.


charlie said:
I am concerned that we might be headed into a period of slow
economic growth with rising inflation (stagflation).  If that occurs,
it is not likely that stock dividends will keep pace with inflation,
IMHO.  If anybody has contrary data, please post it.
I doubt there is any reliable data on the is question. Stagflation was a 70s phenomenon, so I think all we could look at would be those years. I believe dividend grwoth was pretty good in that period, and I think that overall it did or almost did keep up with inflation.

But that is essentially one instance. It would be expecting a lot to think that the 70s pattern would be repeated. IMO, a real wildcard is oil. If the world is relatively supply constrained going forward, one might imagine many, many differences.

One other problem with 100% TIPS -- even if you _could_ keep up with inflation (the real kind, not the hedonic CPI), TIPS would still leave you behind.. Why? Think about how our standard of living creeps up over time -- people have measured this at something like 1% a year in real increases in standard of living.

It might not be an issue for you, but all around you,a f ew decades from now, your peers will be eating at nicer restaurants, staying in nicer places etc in what will by that time be the 'normal' retiree lifestyle. Some of us curmudgeonly types figure we like our lives today and will simply drive a stake in the ground and keep up this exact lifestyle and not worry about keeping abreast of rising norms, but I will go on record that this flies in the face of a lot of what we have come to expect as a human species. We always seem to want things to get a little better every year. Your 100% TIPS would not give you that.

One other problem: all the FIRECalc-type calculators tell you about the chance of avoiding the worst case scenarios etc. Remember, that in 90% or 80% of the cases, you can expect outcomes better, in some cases far better, than these scrape-by scenarios. TIPS eliminate the lows, but they also eliminate the highs. You will never get the outperformance on the upside that any of us with balanced portfolios have a chance (actually a pretty good chance) of getting. You sold off all your upside for the chance to be guaranteed of not having a portfolio value drop in real terms. I think you may find you've paid a high price for 'insuring' that last few percentage points of risk.

One last point -- perhaps too wacky for some. I read an interview today with Pete Peterson, Paul Krugman and one other guy (in Harpers) in which they mentioned that the US. s deficiits (trade and federal budget) unfunded Medicare liabilities and dwindling younger generation to pay taxes put it on a course where 30 years from now, US Govt Debt might not be as secure as we have always assumed it to be. Just like no one could ever imagine GM debt becoming Junk 30 or 40 years ago, no one can imagine US Govt debt becoming junk 30 or 40 years from now (except these guys). Just food for thought when you go 100% into anything for the very long run.
Top Bottom