LMP at age 50 (help with TIPS Ladder)

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Hayden
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LMP at age 50 (help with TIPS Ladder)

Post by Hayden »

Just finished reading Bernstein’s new book. It’s excellent; I highly recommend it. However, it (and the other books I’ve read) have focused on the 65 year old retiree. I need help figuring out how to implement this for my particular situation (early 50s).

From my reading, I think these are the key points for my situation:

Currently age 51. Plan to retire in next year or so (age < 55).

Total portfolio: 5+ M. most in taxable accounts. I believe this will be “enough.”

I won’t withdraw from retirement accounts until I have to take RMDs. I won’t take SS until 70.

Single, no children, no heirs to fund.

I would like to buy TIPS, but I just cannot figure out what makes sense in my case. Eventually, I will want to buy an annuity. So, for example, do I just buy a lot of 30 year TIPS today, with the goal of funding the purchase of the annuity in my early 80s?

Current Portfolio:
30% Total US Stock Market
20% Total International Stock Market
50% Bonds/CDs/I bonds/EE bonds/cash

The bond portion in taxable accounts is in CDs and Vanguard Short and Intermediate Muni Funds. So far, so good. This is what Bernstein recommends.

The question is how best to get TIPS in my retirement accounts. Here is the current status of my retirement accounts:

IRA plus Rollover IRA: current balance: $800 k
Invested entirely in Fidelity Spartan US Bond Index Advantage Class (FSITX)
From my read of Bernstein, this should be in TIPS (actual TIPS, not a Fund). How do I implement this?

Roth IRA: current balance: $60 k
Invested entirely in Schwab US TIPS ETF (SCHP)
Bernstein says not to buy Bond ETFs. So this should go. He recommends stocks in the Roth. I could exchange stocks in taxable for muni funds, and buy stocks here. But, I prefer to wait until at least next year, when I will probably be in a lower tax bracket.

So, how do I implement the LMP in my particular situation? Thanks for your help
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Leesbro63 »

You have a large taxable account. If the very inflation that TIPS are bought to protect against ever rears it's ugly head, you will have a TAXFLATION problem.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Hayden »

Leesbro63 wrote:You have a large taxable account. If the very inflation that TIPS are bought to protect against ever rears it's ugly head, you will have a TAXFLATION problem.
Interesting. How should I deal with that?
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Leesbro63 »

Welcome to my world. I also have a large taxable account and have the same problem. And I've discussed this before on a number of threads. This one became active again recently (I am the original poster of this thread): http://www.bogleheads.org/forum/viewtop ... 0&t=106544

My own conclusion is that for this situation, a 50/50 portfolio (stocks/shorter term bonds) is less risky and makes more sense. I will add that I can live on a 2% withdrawal rate and my joint life expectancy is 30+ years (I'm 54 and my wife is 51). For those who need much more and/or may not have that much time, my risk conclusion might not be true. I almost always remind those reading the LMP threads that an all TIPS LMP doesn't work well for a large taxable account. And to my memory, no one has really shown that I'm wrong (although I am open to criticism and to be shown a better way...in fact, I'm LOOKING for a better way). I even remember Dr. Bernstein somewhat agreeing with me somewhere (although he's never easy to understand and rarely gives "yes" or "no" answers).

So that's my answer: Accumulate enough to live on a low withdrawal rate, invest your stash 50/50 and hope for the best (I guess I would add "pray" if you are religious! 8-) )
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Hayden »

Leesbro63 wrote:Welcome to my world. I also have a large taxable account and have the same problem. And I've discussed this before on a number of threads. This one became active again recently (I am the original poster of this thread): http://www.bogleheads.org/forum/viewtop ... 0&t=106544

My own conclusion is that for this situation, a 50/50 portfolio (stocks/shorter term bonds) is less risky and makes more sense. I will add that I can live on a 2% withdrawal rate and my joint life expectancy is 30+ years (I'm 54 and my wife is 51). For those who need much more and/or may not have that much time, my risk conclusion might not be true. I almost always remind those reading the LMP threads that an all TIPS LMP doesn't work well for a large taxable account. And to my memory, no one has really shown that I'm wrong (although I am open to criticism and to be shown a better way...in fact, I'm LOOKING for a better way). I even remember Dr. Bernstein somewhat agreeing with me somewhere (although he's never easy to understand and rarely gives "yes" or "no" answers).

So that's my answer: Accumulate enough to live on a low withdrawal rate, invest your stash 50/50 and hope for the best (I guess I would add "pray" if you are religious! 8-) )
Leesbro63, thank you, I've been reading your interesting thread, and I need to go back (after work) and read it some more. Very thoughtful.

The reason the LMP appeals to me is that I am one of those people who is afraid to spend money. Likely to work until I die with $10M in the bank. So, I'm thinking that an LMP (or, ultimately, an annuity) will make me comfortable to start spending some of my money.

Any of our TIPS ladder experts to weigh in on how to structure a TIPS ladder in my situation?
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Re: LMP at age 50 (help with TIPS Ladder)

Post by magellan »

Leesbro63 wrote:You have a large taxable account. If the very inflation that TIPS are bought to protect against ever rears it's ugly head, you will have a TAXFLATION problem.
I agree. Consider a $1m portfolio of TIPS in taxable. When inflation is at 2%, the phantom income on the inflation adjustment of TIPS principal is $20k per year. If inflation spikes to 10%, the taxable income jumps to $100k. At 15% inflation, you're looking at $150k in extra taxable income.

IMO, this disqualifies TIPS in taxable as a candidate for a LMP strategy because you can't know how much cash flow to set aside for the taxes on the phantom income from the inflation adjustments on the TIPS.

Jim
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Leesbro63 »

Hayden wrote: The reason the LMP appeals to me is that I am one of those people who is afraid to spend money. Likely to work until I die with $10M in the bank. So, I'm thinking that an LMP (or, ultimately, an annuity) will make me comfortable to start spending some of my money.

Any of our TIPS ladder experts to weigh in on how to structure a TIPS ladder in my situation?
LMP appeals to me too. In theory. In reality it doesn't seem possible for large taxable accounts.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by archbish99 »

I'm not a Bernstein disciple, though I like a lot of his logic. Let me throw out a strategy I've suggested before, and you can see what you think.

What you want LMP for is to create an inflation-adjusted income floor that will persist for the rest of your life. Start by calculating your SS at age 70 assuming you have no SS income after retirement. That will be an amount in present-day dollars, and the inflation-adjustments should keep that relatively constant. (There is some legislative risk, being a good bit less than FRA, but we can't go into that here.) The hope is that, with no debt, this is a floor you can get by with, even if you'd reasonably prefer more.

Then use one of the handy TIPS ladder spreadsheets (see http://www.bogleheads.org/forum/viewtop ... 10&t=93849) to create a TIPS ladder that will pay you that amount in present-day dollars each year. A TIPS ladder will include maturities both very short and very long, but weighted toward the long end. Each year, you'll get an equal amount of inflation-adjusted income from the combination of interest from the bonds still due in the future, plus the bonds maturing in the present year. The ladder will pay out and burn down, reaching zero as you claim SS at age 70, and the Government begins providing you the same amount of inflation-adjusted income from then for the remainder of your life.

The rest of your portfolio can be invested in riskier assets, and withdrawal from that will supplement your base level. (For most people, would say the balance could be invested with a longer time horizon for heirs, but you're not targeting a bequest.) Since you've got plenty of years left, you'd probably want a conservative 2-3% SWR, but you've also got a solid floor that means you can afford to take more in good years and cut back in bad. That's up to your comfort level.

You're right that the best place to hold individual TIPS is a Traditional account. If your ladder is more than $800k, hold the longer-term TIPS in the IRA and the shorter-term in taxable. As the TIPS throw off money in the Traditional account, put the proceeds into equity and exchange out of equity in your taxable account to keep things balanced. Net effect is that your TIPS are sheltered, but you're still taking their return as present income. The main ugliness of individual TIPS is that the inflation-adjustment on the principal is taxable as if it were current income, but it's not actually spendable until the bond matures. You want to get the taxability of that adjustment as close as possible to when you actually receive it, which is what the TIRA does for you.

Does that seem like something that might help you be more comfortable with spending down your earnings?
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Re: LMP at age 50 (help with TIPS Ladder)

Post by market timer »

How much income are you looking to generate from your annuity after age 80? Presumably, by delaying SS until age 70, you'll have enough monthly income to meet the necessities. I think a very conservative, TIPS-based LMP makes the most sense for people with modest portfolios, where most of the anticipated withdrawals are intended to cover necessities. In your case, you seem to have ample room to cutback on your withdrawal rate if a bear market hits.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by magellan »

This discussion nicely shows how maintaining the real value of a low-risk taxable portfolio is a very big challenge. TIPS are a special challenge because of immediate taxes due on the inflation adjustments paid out later. But nominal bonds are also a challenge. As inflation increases, the tax bill due on portfolio earnings increases, taking an ever-larger bite out of the portfolio's real value.

As an example, if inflation is 2% and the portfolio return is 3%, with a 25% tax rate the portfolio's real value actually increases by .25% each year. However, with inflation at 9%, portfolio return at 10%, and taxes at 25%, the real value of the portfolio falls by 1.5% each year.

Tax free bonds can help of course, but usually that means taking on more credit risk, increasing duration, or accepting a return that's still lower than the inflation rate. It's a case of having to pick your poison.

Jim
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Re: LMP at age 50 (help with TIPS Ladder)

Post by fmzip »

what does LMP stand for?
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Re: LMP at age 50 (help with TIPS Ladder)

Post by archbish99 »

fmzip wrote:what does LMP stand for?
Liability-Matching Portfolio. Basically, having a floor of guaranteed income (whether SPIA, bond ladders, Social Security, etc.) that will meet your basic needs, so you're less dependent on sequence of returns from riskier assets.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Hayden »

Thank you for all the responses. Your comments and Leesbro63’s other excellent thread have really broadened my thinking on this.

I’m figuring on a 1% withdrawal rate at the start (say, until age 60). I am a person who is afraid to spend; with this plan, I will give myself “permission” to spend 1% a year at first, with the expectation that the withdrawal rate will increase later as I become more comfortable with spending. Market Timer, you are right, once I get to a higher withdrawal rate, I will have no difficulty cutting back on the withdrawal amount if a bear market hits.

Right now, I really enjoy reading the academic articles, books, and particularly spending hours on the bogleheads website. I’m assuming that will not be the case when I’m older. So, I’m planning on purchasing SPIAs, beginning, say, at age 70. So, I had been thinking about investing the IRA funds for the purpose of purchasing those SPIAs (i.e., purchase long TIPS now for that purpose). Archbish99, your post was thought provoking because it was kind of opposite to what I had been thinking about.

The tax issue raised by Leesbro63 and Magellan is a big one. Although my portfolio seems large, I don’t really own it all because the government will get a big chunk. Even today, I have seven figures in unrealized capital gains. As they pointed out, bonds will just add to the tax burden.

I find it interesting that no one suggested purchasing a TIPS mutual fund in my IRA. Given that I don’t really know when I will need the money, I would have thought a TIPS fund would be a good option.

So here’s what I’m thinking now based on the posts I’ve read:

Don’t buy TIPS at this time because rates are so low

Exchange the intermediate term bond fund in my IRA for a conservative short-term bond fund. What fund would you recommend? I don’t know what fund to buy…

Change my current AA (50/50) to something a bit more conservative, e.g., 40/60. This would give me a big capital gains hit, which is painful to me….

What do you think?
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Leesbro63 »

I'd stay 50/50. My guess is that (based on what you posted) the tax cost is too high for the amount of risk reduction you'll get.

Sometimes perfect is the enemy of good enough. If you can live on 1%, the potential tweaks aren't that important. But are costly if they cause you a big tax cost,
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Re: LMP at age 50 (help with TIPS Ladder)

Post by dbr »

Hayden wrote:
I’m figuring on a 1% withdrawal rate at the start (say, until age 60). I am a person who is afraid to spend; with this plan, I will give myself “permission” to spend 1% a year at first, with the expectation that the withdrawal rate will increase later as I become more comfortable with spending. Market Timer, you are right, once I get to a higher withdrawal rate, I will have no difficulty cutting back on the withdrawal amount if a bear market hits.

So 1% on $5MM is still $50K/year. If you are really serious about how you want to spend in retirement, you are good go go. You should stop worrying about LMP and all the rest of that. The one possible risk is that you are way off on what you really want to spend in the sense that you really want to spend $250K/year and not $50K. Is there any chance of that after you realize how much money you have and whether or not $50K really gets you what you want?


Right now, I really enjoy reading the academic articles, books, and particularly spending hours on the bogleheads website. I’m assuming that will not be the case when I’m older. So, I’m planning on purchasing SPIAs, beginning, say, at age 70. So, I had been thinking about investing the IRA funds for the purpose of purchasing those SPIAs (i.e., purchase long TIPS now for that purpose). Archbish99, your post was thought provoking because it was kind of opposite to what I had been thinking about.

The tax issue raised by Leesbro63 and Magellan is a big one. Although my portfolio seems large, I don’t really own it all because the government will get a big chunk. Even today, I have seven figures in unrealized capital gains. As they pointed out, bonds will just add to the tax burden.

You should probably just look at the nitty-gritty of what your tax costs will actually be. You need to lay out what your income will be in those years and estimate actual tax costs. That is better than "government owns my portfolio" mickey-mouse.

I find it interesting that no one suggested purchasing a TIPS mutual fund in my IRA. Given that I don’t really know when I will need the money, I would have thought a TIPS fund would be a good option.

Yes, a TIPS fund is a perfectly good way to hold TIPS in retirement. It is not a liability matching portfolio because an LMP is supposed to be an investment that definitely delivers a known real income each year for some years. A bond ladder where you spend the maturing bonds does that and a TIPS fund can fluctuate in value from year to year as you withdraw bits of it from time to time. But I don't think LMP is a useful concept for you.

So here’s what I’m thinking now based on the posts I’ve read:

Don’t buy TIPS at this time because rates are so low

All bond rates are low. This does not distinguish TIPS from other bonds.

Exchange the intermediate term bond fund in my IRA for a conservative short-term bond fund. What fund would you recommend? I don’t know what fund to buy…

That is not necessary.

Change my current AA (50/50) to something a bit more conservative, e.g., 40/60. This would give me a big capital gains hit, which is painful to me….

You probably shouldn't pay big taxes now just to make a pointless change from 50/50 to 40/60.

What do you think?
Last edited by dbr on Tue Jun 24, 2014 12:32 pm, edited 1 time in total.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by abuss368 »

Leesbro63 wrote:You have a large taxable account. If the very inflation that TIPS are bought to protect against ever rears it's ugly head, you will have a TAXFLATION problem.
This is huge and there is a lot of information on the internet. This is another advantage of a mutual fund rather than individual TIPS. The fund is required to pay out the interest it receives. No "phantom income".

TIPS are exempt from state and local taxes.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by abuss368 »

I would also rather have the low cost and simplicity of a Vanguard mutual fund rather than individual TIPS.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by abuss368 »

With a $5,000,000 portfolio and assume an overall dividend rate of 2.5% - 3.00% (if you have REITs), results in dividends income of $125,000 - $150,000. That is awesome. Congrats!
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Hayden »

To the person who said "you are an idiot" and then edited it out, thanks, really, I think that's what I needed to hear. I'm not being sarcastic -- I really appreciate blunt speaking -- in my real life, i'm the "smart" one and people don't tell me when I'm wrong.

The prospect of possibly facing 50 years in retirement has me scared. I was never risk averse before (e.g., I bought all the way down in 2008/2009, hence my large capital gains). But now I feel like I just want to protect my nest egg.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Kevin M »

In the current environment I prefer good, direct CDs to bond funds for reasons explained in my blog post linked in this BH post: Bogleheads • View topic - GE Capital Retail Bank 5-Year 2.3% CD. A year ago last May I sold all of my short-term investment-grade bond fund in an IRA and transferred the proceeds into a 2% direct CD. I see no point in owning a short-term bond fund other than 401k/403b restrictions and liquidity.

I also don't like TIPS at current rates. With current, low inflation, you're getting a zero or slightly positive real return on a 2.3% CD. TIPS have negative real yields up to and somewhat beyond 5-year maturities. The low early withdrawal penalty of six months of interest on the CD provides a cheap put to hedge against unexpected increase in inflation and interest rates.

Of course I Bonds are great at a slightly positive real yield, but annual purchase limits reduce their usefulness in your situation; I still max out my annual purchase limit, which is $20K because I buy $10K in the name of my living trust. At that rate you could build up $400K over the next 20 years (at least in nominal terms; who knows what they'll do with the limits in the future).

My situation is not that different from yours. I retired at age 55, and am now 62. I've maintained a 30/70 stock/fixed-income AA, since I don't see the need to take more risk than that. I'm a fan of the LMP/RP paradigm, but I don't see the need to make any big changes, since I think the 70% in FI provides my LMP. My fixed income is 70% direct CDs, 25% bond funds (mostly intermediate-term investment-grade and tax-exempt), and 5% cash (much of it earning more than a high-quality, short-term bond fund). I just moved another 5% or so from bond funds to CDs. Technically my bond funds are part of my RP, since they have some credit risk and term risk, but of course they are much less risky than stocks.

I don't see annuities in my future, and not sure you'll need them either, but who knows. Unlike you I do have heirs, and would prefer to pass something on to them instead of the insurance companies. At any rate, no need to make that decision now, especially with a 1% or even 2% withdrawal rate.

Kevin
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Leesbro63 »

Hayden wrote:To the person who said "you are an idiot" and then edited it out, thanks, really, I think that's what I needed to hear. The prospect of possibly facing 50 years in retirement has me really scared. I was never risk averse before (e.g., I bought all the way down in 2008/2009, hence my large capital gains). But now I feel like I just want to protect my nest egg.
It's sad that people resort of name calling when someone is looking for advice on a serious issue. My situation isn't quite the same as yours but there are lots of parallels. I, too, worry about a rapid or even just a slow grinding decline in my ability to maintain my lifestyle and support my family. It's not abnormal to be scared. But here is the bottom line: There is no way to become 100% secure. Dr. Bernstein's somewhere said (I'm paraphrasing from memory) that once you get beyond 80% certainty of a "safe withdrawal rate", it's a fool's errand. Because meteorites, politicians and other uncontrollable events take up at least 20%.

So at some point you are going to have to make peace with the fact that there are going to be rough patches. And there is a small chance it WON'T all work out. But you also should embrace the fact that YOU DUN GOOD and made your path so that the odds are good that it WILL work out. I struggle with this all the time too. Frankly, I think if you limit yourself to a 1% withdrawal rate you are punishing yourself too hard. A while back Rick Ferri said that he advises his clients to spend their income...dividends and interest and distributed capital gains. In today's world, with a 50/50 portfolio (about where I am), that's about 2.5%. You do have to pay taxes out of that. So it's about 2% left for spending. I think that's a good rule of thumb.

There is no 100% security!

If you want to talk more about this, private message me since we are quite alike here.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by abuss368 »

Kevin M wrote:In the current environment I prefer good, direct CDs to bond funds for reasons explained in my blog post linked in this BH post: Bogleheads • View topic - GE Capital Retail Bank 5-Year 2.3% CD. A year ago last May I sold all of my short-term investment-grade bond fund in an IRA and transferred the proceeds into a 2% direct CD. I see no point in owning a short-term bond fund other than 401k/403b restrictions and liquidity.

I also don't like TIPS at current rates. With current, low inflation, you're getting a zero or slightly positive real return on a 2.3% CD. TIPS have negative real yields up to and somewhat beyond 5-year maturities. The low early withdrawal penalty of six months of interest on the CD provides a cheap put to hedge against unexpected increase in inflation and interest rates.

Of course I Bonds are great at a slightly positive real yield, but annual purchase limits reduce their usefulness in your situation; I still max out my annual purchase limit, which is $20K because I buy $10K in the name of my living trust. At that rate you could build up $400K over the next 20 years (at least in nominal terms; who knows what they'll do with the limits in the future).

My situation is not that different from yours. I retired at age 55, and am now 62. I've maintained a 30/70 stock/fixed-income AA, since I don't see the need to take more risk than that. I'm a fan of the LMP/RP paradigm, but I don't see the need to make any big changes, since I think the 70% in FI provides my LMP. My fixed income is 70% direct CDs, 25% bond funds (mostly intermediate-term investment-grade and tax-exempt), and 5% cash (much of it earning more than a high-quality, short-term bond fund). I just moved another 5% or so from bond funds to CDs. Technically my bond funds are part of my RP, since they have some credit risk and term risk, but of course they are much less risky than stocks.

I don't see annuities in my future, and not sure you'll need them either, but who knows. Unlike you I do have heirs, and would prefer to pass something on to them instead of the insurance companies. At any rate, no need to make that decision now, especially with a 1% or even 2% withdrawal rate.

Kevin
Kevin,

Excellent points indeed. One follow up question regarding TIPS. Not a market timing question, but for someone who wanted to add TIPS to a portfolio, it probably does not matter over the long term correct?
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Re: LMP at age 50 (help with TIPS Ladder)

Post by #Cruncher »

abuss368 in [url=http://www.bogleheads.org/forum/viewtopic.php?p=2100337#p2100337]this post[/url] wrote:
Leesbro63 in [url=http://www.bogleheads.org/forum/viewtopic.php?p=2099029#p2099029]this post[/url] wrote:You [the original poster] have a large taxable account. If the very inflation that TIPS are bought to protect against ever rears it's ugly head, you will have a TAXFLATION problem.
... This is another advantage of a mutual fund rather than individual TIPS. The fund is required to pay out the interest it receives. No "phantom income".
You are wrong, Abuss. If held in a taxable account, both a TIPS mutual find and individual TIPS suffer the same deterioration in real return if the CPI rises more than was expected. In both cases, the investor has to pay tax annually on the increase in nominal value due to the increase in the CPI. The fact that TIPS funds are required to include this increase in dividend distributions does not reduce the tax owed each year.

Here is a table that illustrates how TIPS held in a taxable account are hurt by larger increases in the CPI, while TIPS held in an IRA (Traditional or Roth) are not. The figures are for $1,000 of pretax wages to be invested in hypothetical TIPS with a real yield of 0% for 30 years. Income tax rates are assumed to stay the same over the 30 years at 25% federal and 5% state. The results are shown for two cases of constant CPI increase per year: 2% and 5%. Since the real yield is assumed to be 0%, the only "income" is the inflation adjustment due to the rising CPI.

Code: Select all

                            Roth IRA          Traditional IRA           Taxable
                         --------------       ---------------       ---------------
CPI Annual Change         2.00%   5.00%       2.00%     5.00%       2.00%     5.00%
                          -----   -----       -----     -----       -----     -----
a  Growth Rate            2.00%   5.00%       2.00%     5.00%       1.50%     3.75%
b  After Tax Investment     700     700       1,000     1,000         700       700
c  Grows To               1,268   3,025       1,811     4,322       1,094     2,112
d  Tax at End                -       -          543     1,297          -         -
e  After Tax              1,268   3,025       1,268     3,025       1,094     2,112
f  Real After Tax           700     700         700       700         604       489
  1. Growth Rate = CPI increase for IRA, CPI increase less 25% federal tax for Taxable
  2. After Tax Investment = $1,000 less 25% federal + 5% state tax for Roth IRA & Taxable
  3. Grows To = After Tax Investment X (1 + Growth Rate) ^ 30
  4. Tax at End = 25% federal + 5% state tax for Trad IRA only
  5. After Tax = Grows To less Tax at End
  6. Real After Tax = After Tax / (1 + Annual CPI Change) ^ 30
In 30 years after taxes one ends up with $700 in real dollars with either the Roth or the Traditional IRA. And this amount is the same regardless of how much the CPI rises. But if the investment was made in a taxable account, in 30 years after taxes one ends up with only $604 in real dollars if the CPI rose 2% per year, and only $489 if the CPI rose 5% per year.

Edit: Added overlooked explanation of item c, "Grows To", in table.
Last edited by #Cruncher on Tue Jun 24, 2014 6:55 pm, edited 1 time in total.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Kevin M »

abuss368 wrote:Not a market timing question, but for someone who wanted to add TIPS to a portfolio, it probably does not matter over the long term correct?
If you mean whether or not to add TIPS to a portfolio when real rates are lower or higher, then better investment minds than mine seem to think it does matter. Bill Bernstein is on record as preferring short-term nominal fixed income to TIPS at current real rates, yet advocates using TIPS in the LMP once TIPS rates improve. Larry Swedroe had this to say in the thread linked by Leesbro63 above:
As Bill notes unfortunately with TIPS yields so low the sustainable withdrawal rate is lower, and shows why IMO one should load up on TIPS and go real long with them when the real yields are high, locking them in and not taking an index type approach. Now I would not lock in long TIPS
To be fair, Larry is not saying to avoid TIPS altogether, but not to lock in low, long-term real rates. Larry has written articles that generally are more positive on short-to-intermediate-term TIPS than nominal treasuries of comparable maturities, but I believe in his own portfolio he shifted entirely out of TIPS and into short-term nominal fixed income some time ago.

Of course there are other knowledgeable Bogleheads who continue to add TIPS, even long-term TIPS, to their portfolios. My personal preference is to keep effective duration short to minimize inflation risk and term risk, and to take advantage of the opportunities provided to retail investors, but not to institutional investors, to maximize yield and minimize credit risk while doing so.

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Re: LMP at age 50 (help with TIPS Ladder)

Post by dbr »

It's not as if locking in low real rates on long term nominal bonds would be superior to locking in low real rates on TIPS.

It is also not as if not locking in low real rates by going short is a solution to the fact that interest rates are low.

It is also not as if the fact that some investments such a CDs and stable value funds yield more than short term bonds is a solution to the fact that interest rates are low.

It is also not as if high prices in annuities when interest rates are low is a solution to the fact that interest rates are low.

What is a solution to the fact that interest rates are low is having more money.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Kevin M »

You don't lock in low real rates by sticking with short-term fixed income. Higher yielding direct CDs and stable-value funds may not be a solution to low rates, but they sure are better than many of the the alternatives, including short-term bonds (IMO). We have to work with the hand we're dealt.

Having more money does help though. As Groucho Marx supposedly replied when someone said Treasury bonds didn't earn much, "They do if you have enough of them".

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Re: LMP at age 50 (help with TIPS Ladder)

Post by abuss368 »

#Cruncher wrote:
abuss368 in [url=http://www.bogleheads.org/forum/viewtopic.php?p=2100337#p2100337]this post[/url] wrote:
Leesbro63 in [url=http://www.bogleheads.org/forum/viewtopic.php?p=2099029#p2099029]this post[/url] wrote:You [the original poster] have a large taxable account. If the very inflation that TIPS are bought to protect against ever rears it's ugly head, you will have a TAXFLATION problem.
... This is another advantage of a mutual fund rather than individual TIPS. The fund is required to pay out the interest it receives. No "phantom income".
You are wrong, Abuss. If held in a taxable account, both a TIPS mutual find and individual TIPS suffer the same deterioration in real return if the CPI rises more than was expected. In both cases, the investor has to pay tax annually on the increase in nominal value due to the increase in the CPI. The fact that TIPS funds are required to include this increase in dividend distributions does not reduce the tax owed each year.

Here is a table that illustrates how TIPS held in a taxable account are hurt by larger increases in the CPI, while TIPS held in an IRA (Traditional or Roth) are not. The figures are for $1,000 of pretax wages to be invested in hypothetical TIPS with a real yield of 0% for 30 years. Income tax rates are assumed to stay the same over the 30 years at 25% federal and 5% state. The results are shown for two cases of constant CPI increase per year: 2% and 5%. Since the real yield is assumed to be 0%, the only "income" is the inflation adjustment due to the rising CPI.

Code: Select all

                            Roth IRA          Traditional IRA           Taxable
                         --------------       ---------------       ---------------
CPI Annual Change         2.00%   5.00%       2.00%     5.00%       2.00%     5.00%
                          -----   -----       -----     -----       -----     -----
a  Growth Rate            2.00%   5.00%       2.00%     5.00%       1.50%     3.75%
b  After Tax Investment     700     700       1,000     1,000         700       700
c  Grows To               1,268   3,025       1,811     4,322       1,094     2,112
d  Tax at End                -       -          543     1,297          -         -
e  After Tax              1,268   3,025       1,268     3,025       1,094     2,112
f  Real After Tax           700     700         700       700         604       489
  1. Growth Rate = CPI increase for IRA, CPI increase less 25% federal tax for Taxable
  2. After Tax Investment = $1,000 less 25% federal + 5% state tax for Roth IRA & Taxable
  3. Grows To = After Tax Investment X (1 + Growth Rate) ^ 30
  4. Tax at End = 25% federal + 5% state tax for Trad IRA only
  5. After Tax = Grows To less Tax at End
  6. Real After Tax = After Tax / (1 + Annual CPI Change) ^ 30
In 30 years after taxes one ends up with $700 in real dollars with either the Roth or the Traditional IRA. And this amount is the same regardless of how much the CPI rises. But if the investment was made in a taxable account, in 30 years after taxes one ends up with only $604 in real dollars if the CPI rose 2% per year, and only $489 if the CPI rose 5% per year.

Edit: Added overlooked explanation of item c, "Grows To", in table.
Thank you for the detailed explanation. I am not sure if I was unclear or perhaps you misunderstood my question. My understanding of TIPS was that a mutual fund is required to pay out any dividend income by year end.

Individual TIPS pay out the interest twice a year. However, the inflation component is adjusted (and taxed) each year but paid out at maturity. Essentially "phantom income".
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Re: LMP at age 50 (help with TIPS Ladder)

Post by watchnerd »

magellan wrote: If inflation spikes to 10%, the taxable income jumps to $100k. At 15% inflation, you're looking at $150k in extra taxable income.
Is anyone serious (goldbugs disqualified) actually forecasting double digit inflation in the US any time in the near-medium turn?

Most of the concerns I've read about are the opposite -- deflation fears, think the Fed should raise inflation target to 4%, etc.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by magellan »

watchnerd wrote:Is anyone serious (goldbugs disqualified) actually forecasting double digit inflation in the US any time in the near-medium turn?
My comment was just to illustrate the considerable risk in the real cash flows from a TIPS portfolio held in a taxable account. It wasn't meant as a prediction. That said, I don't think it's unreasonable to expect inflation to hit 5-10% at over the next 40-50 years.

A liability matched portfolio is intended to be a near zero risk way to fund essential retirement expenses by matching real cash inflows to real cash outflows. The taxation of TIPS makes it tough to do this with any degree of certainty if the TIPS have to be held in a taxable account.

If you were to back test this strategy using historical data in the same way we evaluate safe withdrawal rates, it would likely fail more often than it succeeds if the TIPS aren't held in a tax deferred account. To get the approach to back test with a reasonable probability of success, you'd probably need to increase the starting TIPS portfolio size by 10-20% or more.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by InvestingGeek »

Kevin M wrote: Tue Jun 24, 2014 12:49 pm In the current environment I prefer good, direct CDs to bond funds for reasons explained in my blog post linked in this BH post: Bogleheads • View topic - GE Capital Retail Bank 5-Year 2.3% CD. A year ago last May I sold all of my short-term investment-grade bond fund in an IRA and transferred the proceeds into a 2% direct CD. I see no point in owning a short-term bond fund other than 401k/403b restrictions and liquidity.

I also don't like TIPS at current rates. With current, low inflation, you're getting a zero or slightly positive real return on a 2.3% CD. TIPS have negative real yields up to and somewhat beyond 5-year maturities. The low early withdrawal penalty of six months of interest on the CD provides a cheap put to hedge against unexpected increase in inflation and interest rates.

Of course I Bonds are great at a slightly positive real yield, but annual purchase limits reduce their usefulness in your situation; I still max out my annual purchase limit, which is $20K because I buy $10K in the name of my living trust. At that rate you could build up $400K over the next 20 years (at least in nominal terms; who knows what they'll do with the limits in the future).

My situation is not that different from yours. I retired at age 55, and am now 62. I've maintained a 30/70 stock/fixed-income AA, since I don't see the need to take more risk than that. I'm a fan of the LMP/RP paradigm, but I don't see the need to make any big changes, since I think the 70% in FI provides my LMP. My fixed income is 70% direct CDs, 25% bond funds (mostly intermediate-term investment-grade and tax-exempt), and 5% cash (much of it earning more than a high-quality, short-term bond fund). I just moved another 5% or so from bond funds to CDs. Technically my bond funds are part of my RP, since they have some credit risk and term risk, but of course they are much less risky than stocks.

I don't see annuities in my future, and not sure you'll need them either, but who knows. Unlike you I do have heirs, and would prefer to pass something on to them instead of the insurance companies. At any rate, no need to make that decision now, especially with a 1% or even 2% withdrawal rate.

Kevin
Informative post. How did you reach your current allocation? I'm facing a similar problem: large taxable account nearly at LMP level. I would like to increase FI component without triggering capital gains.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by watchnerd »

magellan wrote: Tue Jul 11, 2017 6:01 am
watchnerd wrote:Is anyone serious (goldbugs disqualified) actually forecasting double digit inflation in the US any time in the near-medium turn?
My comment was just to illustrate the considerable risk in the real cash flows from a TIPS portfolio held in a taxable account. It wasn't meant as a prediction. That said, I don't think it's unreasonable to expect inflation to hit 5-10% at over the next 40-50 years.

A liability matched portfolio is intended to be a near zero risk way to fund essential retirement expenses by matching real cash inflows to real cash outflows. The taxation of TIPS makes it tough to do this with any degree of certainty if the TIPS have to be held in a taxable account.

If you were to back test this strategy using historical data in the same way we evaluate safe withdrawal rates, it would likely fail more often than it succeeds if the TIPS aren't held in a tax deferred account. To get the approach to back test with a reasonable probability of success, you'd probably need to increase the starting TIPS portfolio size by 10-20% or more.
Ah.

Well, as I'm still working, I don't follow an LMP-in-TIPS approach, where multi decades of life expenses are held in TIPS.

I hold enough in taxable short TIPS to get through a bad bear market. About 6 years at the moment.
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Kevin M »

InvestingGeek wrote: Tue Apr 07, 2020 11:10 pm
Kevin M wrote: Tue Jun 24, 2014 12:49 pm <snip>
My situation is not that different from yours. I retired at age 55, and am now 62. I've maintained a 30/70 stock/fixed-income AA, since I don't see the need to take more risk than that. I'm a fan of the LMP/RP paradigm, but I don't see the need to make any big changes, since I think the 70% in FI provides my LMP. My fixed income is 70% direct CDs, 25% bond funds (mostly intermediate-term investment-grade and tax-exempt), and 5% cash (much of it earning more than a high-quality, short-term bond fund). I just moved another 5% or so from bond funds to CDs. Technically my bond funds are part of my RP, since they have some credit risk and term risk, but of course they are much less risky than stocks.
<snip.
Informative post. How did you reach your current allocation? I'm facing a similar problem: large taxable account nearly at LMP level. I would like to increase FI component without triggering capital gains.
Wow, asking about a post from almost six years ago!

I'm not sure what you mean by the underlined question. With respect to "without triggering capital gains", there may not be a way to reduce your stock allocation and increase your FI allocation if most or all of your stocks are in taxable with unrealized gains. A big enough drop in stocks might help with that, but one of the reasons to reduce exposure to riskier assets is to avoid a big loss when you don't need to take the risk, so it wouldn't make sense to wait for a big drop in stocks just to reduce your LTCG tax.

A lot of my taxable account came from the sale of rental real estate in late 2005, and although I paid some LTCG tax, it wasn't much, because the basis of those properties was stepped up to market value when my wife died in 2004. I value averaged that into stocks and bonds over a period of years to get to my 30/70 portfolio, including during the 2008/2009 GFC.

Kevin
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Re: LMP at age 50 (help with TIPS Ladder)

Post by Blender »

Kevin M wrote: Wed Apr 08, 2020 5:40 pm Wow, asking about a post from almost six years ago!
Yeah, I read the first post and thought wow! Bernstein has a new book? Spent 10 minutes trying to find it before coming back here and seeing the date :annoyed
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Re: LMP at age 50 (help with TIPS Ladder)

Post by InvestingGeek »

Kevin M wrote: Wed Apr 08, 2020 5:40 pm
InvestingGeek wrote: Tue Apr 07, 2020 11:10 pm
Kevin M wrote: Tue Jun 24, 2014 12:49 pm <snip>
My situation is not that different from yours. I retired at age 55, and am now 62. I've maintained a 30/70 stock/fixed-income AA, since I don't see the need to take more risk than that. I'm a fan of the LMP/RP paradigm, but I don't see the need to make any big changes, since I think the 70% in FI provides my LMP. My fixed income is 70% direct CDs, 25% bond funds (mostly intermediate-term investment-grade and tax-exempt), and 5% cash (much of it earning more than a high-quality, short-term bond fund). I just moved another 5% or so from bond funds to CDs. Technically my bond funds are part of my RP, since they have some credit risk and term risk, but of course they are much less risky than stocks.
<snip.
Informative post. How did you reach your current allocation? I'm facing a similar problem: large taxable account nearly at LMP level. I would like to increase FI component without triggering capital gains.
Wow, asking about a post from almost six years ago!

I'm not sure what you mean by the underlined question. With respect to "without triggering capital gains", there may not be a way to reduce your stock allocation and increase your FI allocation if most or all of your stocks are in taxable with unrealized gains. A big enough drop in stocks might help with that, but one of the reasons to reduce exposure to riskier assets is to avoid a big loss when you don't need to take the risk, so it wouldn't make sense to wait for a big drop in stocks just to reduce your LTCG tax.

A lot of my taxable account came from the sale of rental real estate in late 2005, and although I paid some LTCG tax, it wasn't much, because the basis of those properties was stepped up to market value when my wife died in 2004. I value averaged that into stocks and bonds over a period of years to get to my 30/70 portfolio, including during the 2008/2009 GFC.

Kevin
I just meant how you reached the 30/70 ratio in taxable and you've answered it. Thanks!
Blender wrote: Wed Apr 08, 2020 8:42 pm
Kevin M wrote: Wed Apr 08, 2020 5:40 pm Wow, asking about a post from almost six years ago!
Yeah, I read the first post and thought wow! Bernstein has a new book? Spent 10 minutes trying to find it before coming back here and seeing the date :annoyed
Yes sorry about reviving a zombie thread but that's the value of this forum - the experiences one can learn about are timeless.
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