Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

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Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby Blues » Fri Jun 28, 2013 10:46 am

I was interested in getting the point of view of other forum members on a comparison of the Target Retirement Income Fund (VTINX) versus a 50/50 blend of LifeStrategy Conservative Growth (VSCGX) and LifeStrategy Income (VASIX).

Where they would be the same:

Both the TR Income Fund and the blend of the two LS funds would provide an investor with a 30% allocation to equities: 21% TSM, 9% TI
Each would also provide a 14% allocation to Total International Bond.

Where they differ:

The TR fund would provide a 40% allocation to TBM and 16% to ST TIPS.

The LS blend would provide a 56% allocation to TBM (and 0% to ST TIPS).

Costs:

The TR fund has a .16% ER
The LS blend has a .145% ER

For the sake of argument, let's limit the discussion to these two options, (as opposed to purchasing the underlying funds separately or introducing other funds into the equation), within a tax advantaged account.

I'm curious to hear if you feel that the 16% allocation to ST TIPS would induce you to select or reject one or the other of the options, whether you think a 16% allocation is sufficient or meaningful given the portfolio construction, and finally, whether including ST TIPS within the retirement fund is a superior option when compared to the longer term TIPS fund previously offered. (Realizing in advance that ST TIPS would ordinarily have less interest rate sensitivity but also lower yield.)

Thanks for sharing your thoughts.

(The topic was motivated by the question of whether ST TIPS would be a worthwhile addition to a COLA'd federal pension, a significant allocation to the TSP "G" Fund, a small allocation to I-Bonds and future COLA'd Social Security benefits (several years hence). The current portfolio includes all of the underlying funds but for ST TIPS.)
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby G-Money » Fri Jun 28, 2013 11:22 am

Short answer: Between the two options, I'd choose the Target Retirement Fund. But that has more to do with preferring to hold a single fund-of-funds, rather than a combination of two. If I'm going to have the convenience of a one-fund solution, I wouldn't want to muck it up by holding two one-fund solutions. :)

Blues wrote:I'm curious to hear if you feel that the 16% allocation to ST TIPS would induce you to select or reject one or the other of the options

Not for me. High-quality investment grade bonds (i.e., >50% US govt backed) are high-quality investment grade bonds. I don't expect a big difference in performance between the 56/14 combo of TBM/TIBM and 40/16/14 TBM/STIPS/TIBM.

Blues wrote:whether you think a 16% allocation is sufficient or meaningful given the portfolio construction

I think a 16% allocation to a fund is meaningful (I wouldn't put 16% of my portfolio on lotto tickets). But, in the context of high-quality investment grade bonds, I don't think it makes a real difference if you switch between one and another. The shorter duration of the ST TIPS fund will likely have a bigger impact (lower expected returns, lower risk) than the fact that they're TIPS. Since the ST TIPS replaced a combination of Prime MM and the intermediate/long TIPS fund, the switch to ST TIPS probably has not meaningfully changed the expected returns or the risk/volatility of the Target Retirement Fund.

Blues wrote:and finally, whether including ST TIPS within the retirement fund is a superior option when compared to the longer term TIPS fund previously offered. (Realizing in advance that ST TIPS would ordinarily have less interest rate sensitivity but also lower yield.)

Compared to the combination of Prime MM and TIPS that was in the prior iteration, there's probably not much of a difference. I think over the last few years, many investors got tired of seeing 5% of their portfolio in a fund yielding 0.01%, which is probably lower than what their checking account is paying.

I'm a long way from retirement, so I currently prefer the longer-term TIPS fund. If I was actually in or fast-approaching retirement, maybe my attitude would change. I think for retired investors who value diminished portfolio volatility, the use of the shorter-term TIPS fund would be an improvement, but only a modest one over the Prime/TIPS combo.
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby nisiprius » Fri Jun 28, 2013 11:25 am

I would say that the amount of TIPS in the Target Retirement funds can't possibly be enough to make much difference. Just as the amount of the International Bond Index Fund can't be.
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby KyleAAA » Fri Jun 28, 2013 11:27 am

I vote TIPS. The cost difference is minimal and I like the idea of just owning one fund. As far as short versus intermediate-term TIPS, I would guess short-term TIPS would correlate much better with actual inflation, especially sudden inflation.
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby G-Money » Fri Jun 28, 2013 11:51 am

KyleAAA wrote:As far as short versus intermediate-term TIPS, I would guess short-term TIPS would correlate much better with action inflation, especially sudden inflation.

Vanguard agrees: The long and short of TIPS
We found that the return on a short-term TIPS benchmark (of 0-to-5-year
maturities) has been more highly correlated to actual monthly and yearly
CPI (Consumer Price Index) inflation than other segments of the U.S. TIPS
market over the past decade. Although, in practice, all TIPS securities
receive the same CPI principal adjustment, short-term TIPS returns tend to most
closely track actual CPI inflation because of their lower duration and greater
responsiveness to temporary, unexpected inflation spikes.

https://institutional.vanguard.com/iam/pdf/ICRLSTPS.pdf
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby Blues » Fri Jun 28, 2013 1:47 pm

Thank you, gentlemen. I appreciate the input. Hopefully we'll get a few others who may be willing to share their thoughts. :beer
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby dbr » Fri Jun 28, 2013 2:02 pm

G-Money wrote:
KyleAAA wrote:As far as short versus intermediate-term TIPS, I would guess short-term TIPS would correlate much better with action inflation, especially sudden inflation.

Vanguard agrees: The long and short of TIPS
We found that the return on a short-term TIPS benchmark (of 0-to-5-year
maturities) has been more highly correlated to actual monthly and yearly
CPI (Consumer Price Index) inflation than other segments of the U.S. TIPS
market over the past decade. Although, in practice, all TIPS securities
receive the same CPI principal adjustment, short-term TIPS returns tend to most
closely track actual CPI inflation because of their lower duration and greater
responsiveness to temporary, unexpected inflation spikes.

https://institutional.vanguard.com/iam/pdf/ICRLSTPS.pdf


The concept that the investment is "insured" against the effect of inflation and the concept that the investment should track the CPI are two different things. The question is what does the investor want. One option is higher real return while being insured against inflation but at real interest rate risk. A different option is lower real interest rate risk at the cost of real return, while being insured against inflation risk.
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby Blues » Fri Jun 28, 2013 2:09 pm

dbr wrote:The concept that the investment is "insured" against the effect of inflation and the concept that the investment should track the CPI are two different things. The question is what does the investor want. One option is higher real return while being insured against inflation but at real interest rate risk. A different option is lower real interest rate risk at the cost of real return, while being insured against inflation risk.


I think that states the issue pretty clearly. In my mind, I can't quite seem to marry the idea of the short term TIPS with the other holdings in the TR fund.

To my way of thinking, (and admittedly it may be wrong), it seems that the longer term TIPS fund would be more consistent with and a better fit for the other components of the fund though I understand the potential attraction of lower volatility at the expense of yield.

The larger question may in fact be whether we personally have a need for TIPS at all. (And which, currently, we do not own.)
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby grabiner » Fri Jun 28, 2013 7:36 pm

How sensitive are you to inflation? Adding TIPS to your portfolio reduces the risk that inflation will erode the purchasing power, but you pay for that reduction.

So, will your expenses and the rest of your income rise with inflation? If you own a home mortgage-free, or rent a home, your expenses will rise with inflation; if you own a home with a fixed-rate mortgage, your mortgage payments are not affected by inflation. If your other income is from Social Security or a government pension, it will rise with inflation; if it is from a fixed-dollar private pension, it won't rise.

Thus, unless you have both inflation-adjusted pensions and fixed-dollar expenses (from a mortgage), you are sensitive to inflation risk, and I would recommend holding some TIPS. Conversely, if you have a fixed-dollar pension and a lot of inflation-linked expenses (renting a home), you want a lot of TIPS and might be better off with a separate longer-term TIPS fund for part of your portfolio.
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby Blues » Fri Jun 28, 2013 7:53 pm

Thanks for chiming in, David, since you always address wrinkles I hadn't fully considered.

(And thanks again to all who have taken the time to respond to this point.)

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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby joe8d » Fri Jun 28, 2013 7:54 pm

I would just use LS Conservative (40/60) and add a separate TIPS Fund to dilute to desired AA.
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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby Kevin M » Fri Jun 28, 2013 10:36 pm

I wouldn't do either because there's too much interest-rate risk having all of your fixed income in bond funds, but given your constraints, I don't think the relatively small amount of TIPS in the TR fund makes enough difference to matter much.

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Re: Target Retirement vs. LifeStrategy Funds: TIPS / No TIPS

Postby Blues » Fri Jun 28, 2013 11:01 pm

Kevin M wrote:I wouldn't do either because there's too much interest-rate risk having all of your fixed income in bond funds, but given your constraints, I don't think the relatively small amount of TIPS in the TR fund makes enough difference to matter much.

Kevin


Kevin, that's why I couched the question in the OP as I did. Precisely because over 70% of our fixed income is in other investments which are not subject to interest rate risk (and thus less than 30% of our fixed income portfolio would reside in either the LS or TR fund).

In the end, it probably wouldn't be worth our while switching from the blended LS funds to the TR fund simply because the ST TIPS, as a percentage of our entire portfolio, would fall short of 5%...which would barely move the needle. On the other hand, it would remove one of the "all in one" funds from the equation, so that's a plus on the "simplicity" side. Additionally, plugging in the hypothetical / proposed change on the Vanguard site doesn't result in much of a difference whatsoever in terms of the overall allocation and expected results. The difference in cost due to the change in expense ratio is negligible. So, I may just go ahead and make the change on that basis.

In any case, I am grateful for folks having shared how they perceive the addition (or absence) of ST TIPS within the applicable LS/TR funds.
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