What's An Investor to Do?

[bschultheis]

. . . weight a portfolio heavily toward TIPS, as suggested (implied?) by James Stewart, in his NYT column today titled 'Conceived By Students, a Portfolio That Pays"

or avoid TIPS, as suggested by Brett Arends in his WSJ column today titled, "Looking for Inflation Protection? Take TIPS Off Your List." ?

Maybe the simplicity of a Coffeehouse-type portfolio (with a commitment to financial planning) isn't such a bad idea after all - these - years. . .


Bill Schultheis

[pkcrafter]

Here you go, Bill,

Arends, WSJ

http://online.wsj.com/article/SB10001424127887323926104578274092608325904.html

Stewart, Business Day, WSJ

http://www.nytimes.com/2013/02/02/business/a-prize-winning-plan-for-investing-when-interest-rates-are-low.html?pagewanted=1&_r=0&ref=jamesbstewart

Paul

[nisiprius]

Well, Arends has been annoying me for years and I wouldn't trust a thing he says. He's the one who wrote an apparently-not-joking article, Putting Your Emergency Money in Blue Chips: With Cash Accounts Offering Negligible Interest, Stashing Some Emergency Money in Blue-Chip Stocks Could Pay Dividends. See, when you divide the last dividend payment that was made by the current price of the stock, the quotient is a bigger number than it is for a bank account, ergo it must be a better investment.

I'm about to look at the article but the last time he ranted against TIPS, he deliberately confused the issue of "returns" and "real returns," describing them as investments that are "guaranteed to lose money." In every other context but dishonest attacks on TIPS, to "lose money" means a smaller number of dollars, and nominal returns are understood unless otherwise stated. Let me see whether he does it again, today.

Yes, he does.

Here's the earlier column, May 6, 2011.Holding TIPS Will Make You Poorer: Millions of people are holding an investment guaranteed to lose money, writes Brett Arends.

So, what happened since then?

My own portfolio of TIPS, acquired over a decade, is, of course, "making money" and increasing in real value. Now, let's see what happened to someone who invested in VIPSX on May 6, 2011, the day he warned that TIPS would "make you poorer." And, taking a big (psychological) risk here, let's see how it compared to someone who invested in one of his dividend stocks. I'm going to use whatever U.S. stock he mentions first in his "emergency money" article. I don't know how it will turn out and I'll show the result either way. Given what the stock market has been doing, the stock should do much better than the TIPS fund. OK. The first stock he mentions: "AT&T yields about 5.7%." And, inflation, total inflation 5/2011 to today, 229.601 today = 225.964 then so divide final numbers by 1.016 to correct for inflation.



So, $10,000 invested on 5/6/2011 grew to $11,436.62 in the TIPS fund and to $12,485.35. Correcting to 5/2011 dollars, the numbers become $11255.46 and $12287.23 respectively. So there's no question:

• BOTH the TIPS fund Arends hates and the dividend-paying stock he loves made money, and made you wealthier in inflation-adjusted purchasing power.
• The stock made considerably more, but the TIPS fund did just fine, 6.8% real, annualized, if my calculations are right.
• The TIPS fund grew in value fairly smoothly, without abrupt ups and downs.
• AT&T stock was clearly a much risker investment. Looking at just the drops, it dropped 8% in value over a period of a couple of months not once but twice, during a period of relative economic and stock-market stability. This is not emergency-fund behavior. Receiving a quarterly dividend of $0.43 on 7/6/2011 from a stock priced at $31.23 is not like withdrawing $0.43 from a bank account with $31.23 in it--not unless drawing $0.43 from the bank account causes the account balance to drop by $2.92.

In short: the TIPS fund made money and earned a tidy real yield. The "blue-chip" stock made more money and earned a larger real yield. The additional returns were obviously an additional reward for much higher risk.

Just like everyone always thought.

[umfundi]

Nisiprius,

This is slightly off the point, but you might look at what happens if 4% of the starting value is withdrawn from each every year.

Keith

[Bustoff]

Punxsutawney Phil just predicted an early spring. Surely someone has down the analysis.

[nisiprius]

This is slightly off the point, but you might look at what happens if 4% of the starting value is withdrawn from each every year.

What's an investor to do? I ain't saying "use TIPS." I ain't saying "don't use TIPS." I am saying "Don't listen to Brett Arends, he's not seeking to inform, but to persuade.

As for 4%, for TIPS, which provide a known value for real return, the answer is reasonably clear. If TIPS are returning more than about 1.31% real return, which they currently are not, then TIPS will provide a 4% withdrawal rate for exactly thirty years, at which point the portfolio is exactly exhausted--no margin of safety. People have done spreadsheets taking account of real-world considerations like interest payments being at 6-month intervals instead of continuous, and it's not very far off the simple amortization calculation.

If TIPS are returning more than 0% real return, which they current are for any real-world portfolio that includes some past purchases and will include some future purchases, then they will not provide 4%, but they will provide 3.33%.

If you invest your entire fixed-income allocation all at once in current 10-year TIPS, and assume that ten years from now you will not be able to reinvest at any higher rate, then, no, they won't even provide 3.33% withdrawals.

[telemark]

Ignoring the noise is always a good choice. Oh, and don't reach for yield.

[umfundi]

This is slightly off the point, but you might look at what happens if 4% of the starting value is withdrawn from each every year.

What's an investor to do? I ain't saying "use TIPS." I ain't saying "don't use TIPS." I am saying "Don't listen to Brett Arends, he's not seeking to inform, but to persuade.

As for 4%, for TIPS, which provide a known value for real return, the answer is reasonably clear. If TIPS are returning more than about 1.31% real return, which they currently are not, then TIPS will provide a 4% withdrawal rate for exactly thirty years, at which point the portfolio is exactly exhausted--no margin of safety. People have done spreadsheets taking account of real-world considerations like interest payments being at 6-month intervals instead of continuous, and it's not very far off the simple amortization calculation.

If TIPS are returning more than 0% real return, which they current are for any real-world portfolio that includes some past purchases and will include some future purchases, then they will not provide 4%, but they will provide 3.33%.

If you invest your entire fixed-income allocation all at once in current 10-year TIPS, and assume that ten years from now you will not be able to reinvest at any higher rate, then, no, they won't even provide 3.33% withdrawals.

Nisiprius,

My point was going to be around the risk of sequence of returns. The lower value early of the stock investment may turn out to be a handicap in a decumulation scenario.

Keith

[Bustoff]

If TIPS are returning more than about 1.31% real return, which they currently are not,

If TIPS are returning more than 0% real return, which they current are

Nisiprius - how do you figure the real return for TIPS ? ( I'm asking because I don't know how and also because I'm trying to decide if I should include them in my portfolio)

[EDN]

I'm just always amazed at the analysis that goes on with TIPS. With all the investments available, they are probably the most straight-forward of anything I can think of. They are the only investment available that earns the return of CPI +/- the real yield.

First, whether should own them or not boils down to one basic question: do you want protection from unexpected inflation? If you are retired, have large nominal income streams, or hold intermediate/longer-term bonds, that is a pretty obvious answer.

Second, the "is now a good time to own TIPS" question is always relative.

--On the plan level, no one can predict if or when inflation will rear its ugly head, so constant exposure is the best decision.

--On the asset class level, there are only a few options that could be considered an alternative--ultra short-term bonds or commodities. The first isn't perfect (less volatility, but less of an inflation hedge), the second isn't really a TIPS alternative (may spike in periods of high inflation, but could have large negative real returns for long periods). But even if they were perfect substitutes, they'd all be priced to offer the same return at any point in time. If they weren't, you'd either have an arbitrage opportunity or the higher expected real returns of the other assets would be compensation for other/additional risks--so you'd have to weigh the tradeoffs. Stocks may do better in the short-run (or much worse) and will probably do better in the long-run, but they aren't hedges, so that's not apples:apples.

Is it really more complicated than this? I never read TIPS articles because I can never imagine what new information (as opposed to noise) could the possibly contain?

Eric

[grok87]

I think its a question of your time horizon. I think if you have a 30 year time horizon, and inflation sensitive retirment income needs then 30 year tips can make sense.
Recently I have sold all my TIPs- sold out of my 30 year tips when real rates got to around 0.25%.
I'm not excited about buying short to intermediate term tips. But 30 year TIPs rates have ticked up a bit recently to around the 0.5% level. I plan on buying some at the 30 year TIPs auction later this month. For me the 30 year time horizon still makes sense to fund/match retirement income needs. I'm hoping real rates get back to above the 1% level at which point I would be a more aggressive buyer.
cheers,

[ofcmetz]

If you had a stable value fund paying 3%, would you then buy a TIP's fund with a -1% yield?

[Clive]

If TIPS are returning more than about 1.31% real return, which they currently are not,

If TIPS are returning more than 0% real return, which they current are

Nisiprius - how do you figure the real return for TIPS ? ( I'm asking because I don't know how and also because I'm trying to decide if I should include them in my portfolio)

Courtesy

TIPS have fedral tax applied to both the inflation uplift and income (?). So ideally you'd want to be holding TIPS in tax efficient space. If you loaded 10% each year into a 10 year TIPS, after 10 years you'd be holding a range of real yields (average of those 10 year real yields), and the TIPS bought 10 years ago would be maturing (maybe to be rolled into another (current) 10 year TIPS). A guess (by eye) is maybe that ladder would currently be yielding around 1.5% real - but rolling maturing bonds into lower (negative) real yields - such that the current trend would be downwards (10 year average being dragged down by maturing higher real yields rolling into lower real yields).

The difference between TIPS real yield and conventional bond (treasury) yield of the same term is generally the markets estimation of what inflation will average over those years (term).

The angle nisiprius is coming from is that you have enough to support 30 years of withdrawals (income). So if you draw 3.33% (inflation uplifted) each year for 30 years you'll have spent all of that - assuming the TIPS pace inflation.

You can see a snapshot of recent treasury real yields here

Hope this helps.